In this essay I will examine the investor behavior during the South Sea Bubble around 1720 and the involved South Sea Company. Nearly 300 years ago at the London Stock Exchange formed an enormous speculative bubble. In the eighteenth century the trade brought exotic products, such as commodities and slaves with exorbitant profits. This benefited appropriate commercial companies like the trading company South Sea Company. Its share price exploded from 120 to 950 pounds. Trigger of the former stock market crash: The South Sea Company did not have enough cash to pay overdue dividends.
Therefore, I will try to reflect the investor behaviour at that time to maintain more information about why they act like they act. Additionally, I want to give a small outlook on equity valuation the time of the South Sea Bubble. My intent is not to deliver a detailed calculation of shares, rather to investigate the valuation at that time and thus to represent the theory of the pricing relationship. Second it should demonstrate the purpose of the subscription finance and its implementation. In 1720 and the later eighteenth century subscription finance was one of the great legal and political debates. Therefore, for this article it’s important to give information about subscription shares and the historical background, before investigate the legal and political history of the South Sea Company and to give a context to the eighteen-century for subscription finance and the South Sea Company.
Deducted from this information, the paper will thus investigate what kind of investor behaviour was common and it will try to answer the question if this behaviour was rational or irrational. What different investor strategies can be found in this period and during the bubble, regarding the question which explanations can be found to explain the phenomenon when market prices deviate from fundamental values. Additionally, why investors act how they act settled in an overloaded stock market.
Therefore, the paper focuses on one of the most famous bubbles, that associated with the rise and fall of the South Sea Company during 1720. [...]
Table of Contents
1 Introduction
2 Historical Background to the South Sea Company
3 Subscription shares
4 Investments and Investor Behaviour in the Bubble Crash
5 Conclusion
Research Objectives and Key Topics
This essay examines the investor behavior during the South Sea Bubble of 1720, focusing on the South Sea Company. It aims to analyze whether the speculative actions of investors were rational or irrational, while exploring the function of subscription finance and the underlying market dynamics that led to the boom and subsequent crash.
- The historical development and financial structure of the South Sea Company.
- An analysis of the purpose, implementation, and valuation of subscription shares.
- The impact of market complexity and leverage on investor decision-making.
- A critical evaluation of speculative activity and market failure in 18th-century financial markets.
Excerpt from the Book
3 Subscription shares
Regarding to the context of the South Sea Bubble, one investment needs to be highlighted here, as it was the significant responsible that was overvalued. Subscription Shares may not be suitable as a short-term investment. The worth of a Subscription Share may go down as well as up. They represent a geared investment, so a relatively small movement in the market price of the ordinary shares may result in a disproportionately large movement, unfavorable or favorable. The market price of the Subscription Shares may therefore be volatile. As a result, the value of the investment could fall suddenly or substantially. Investors could lose the entire investment and subscription shares could expire. Worthless if the net asset value of the company is below the final closing price of the subscription share at the end of the life of the subscription shares.
Additionally, subscription shares were sometimes referred to subscription contracts. They could have been possibly viewed as ironclad agreements between the issuer and the subscriber. The subscriber was under strict obligation to pay the instalments on time and in full, otherwise the issuer had a full legal right to recover the instalments at the subscriber’s cost, which included an interest rate. (Shea, 2007, S. 743). Movements in the price of Subscription Shares may not be in line with the movement in the price of the Ordinary Shares. The price of a Subscription Share may not move in line with that of an Ordinary share because other factors contributing to their respective prices. For example, supply and demand, are not directly related to one another and hence are unlikely to change at the same time and in the same manner.
Summary of Chapters
1 Introduction: This chapter introduces the historical phenomenon of the South Sea Bubble, outlines the research interest in investor behavior, and states the intention to analyze pricing theories and the role of subscription finance.
2 Historical Background to the South Sea Company: The author details the founding of the company, its role in managing government debt, and the sequence of events that led to the speculative bubble of 1720.
3 Subscription shares: This chapter analyzes the characteristics, risks, and valuation of subscription shares, defining them as complex, geared investments that acted effectively as forward contracts.
4 Investments and Investor Behaviour in the Bubble Crash: This section investigates the rational and irrational drivers of investor behavior during the market collapse, highlighting the role of leverage, settlement risks, and market manipulation.
5 Conclusion: The author summarizes the findings, concluding that the crash was driven by a combination of speculative mania, synchronization risk, and human error, while reflecting on the importance of learning from financial history.
Keywords
South Sea Bubble, South Sea Company, Investor Behavior, Speculative Bubble, Subscription Shares, Financial Markets, Equity Valuation, Market Crash, Irrationality, Debt Conversion, Financial History, Leverage, Dividend Policy, Stock Market, Economic Crisis
Frequently Asked Questions
What is the core focus of this research paper?
The paper examines the investor behavior during the South Sea Bubble of 1720 and explores the underlying financial mechanisms of the South Sea Company.
What are the primary thematic areas explored?
Key themes include the historical background of the South Sea Company, the valuation and nature of subscription shares, and the analysis of investor rationality during speculative market cycles.
What is the central research question?
The study aims to determine whether the behavior of investors during the 1720 South Sea Bubble was rational or irrational and how market prices deviated from fundamental values.
Which scientific methodology is applied?
The author uses an analytical approach, reviewing existing academic literature and historical financial data to evaluate the pricing relationship of shares and the impact of the bubble on the European stock market.
What topics are covered in the main body?
The main body covers the development of the South Sea Company, the technical details of subscription finance, the mechanics of the market crash, and various hypotheses regarding investor decision-making.
Which keywords best describe this work?
The work is characterized by terms such as South Sea Bubble, subscription shares, investor behavior, speculative bubble, and financial market analysis.
How does the author characterize the nature of subscription shares?
Subscription shares are described as complex, geared investment instruments that functioned effectively as forward contracts, carrying significant settlement risks and volatility.
What role did the "Sword Blade Company" play in the crash?
The Sword Blade Company served as the financial arm of the South Sea Company; its insolvency in September 1720 triggered a rapid decline in South Sea stock prices.
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- Maike Lux (Autor:in), 2016, Investors and their Behavior during the South Sea Bubble, München, GRIN Verlag, https://www.grin.com/document/375481
