Irrational Exuberance and Financial Bubbles

Legends of the Mississippi and South Sea Bubbles have endured today as warnings against the fatality of irrational exuberance in financial markets. However, as details of these first financial crises are somewhat exaggerated, it has proven difficult for historians to separate fact from myth. The question remains as to whether investors behaved irrationally or sensibly in response to these events in the early eighteenth century.

It appears that a lack of investor sophistication and the adverse effects of herding are partly to blame for the unsustainable prices increases. Some argue that ‘irrational exuberance is the psychological basis of a speculative bubble’. However, many historians have rejected that investors acted in a fit of ‘irrational exuberance’, instead determining that they responded sensibly to the information available to them. It seems that a combination of these two theories would best explain the initial extraordinary popularity of these two schemes

It is important, before examining the events of the Mississippi and South Sea Bubbles, to approach the various definitions of the word ‘bubble’. According to the Dictionary of Political Economy (1926), the early modern definition of a bubble is as follows, ‘any unsound undertaking accompanied by a high degree of speculation’. This suggests that the investor basis his undertaking on an unwise or irrational assumption. However, Kindleberger appears to remove the presence of irrationality from the equation, defining a bubble as ‘an upward price movement over an extended range that then implodes’. It is therefore primarily unclear as to whether the very manifestation of a bubble presupposes the existence of investor irrationality.

Before categorising the victims ...

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...rst Bubbles: The Fundamentals of Early Manias (Cambridge: MIT Press, 2000).

• Hoppit, Julian, ‘The Myths of the South Sea Bubble’, Transaction of the Royal Historical Society, Sixth Series, Vol. 12 (2002), pp. 141-65.

• Kindleberger, Charles and Robert Z. Aliber, Manias, Panics and Crashes: A History of Financial Crises (New York: Palgrave Macmillan, 2011).

• MacKay, Charles, Memoirs of Extraordinary Popular Delusions and the Madness of Crowds (London: Office of the National Illustrated Library, 1852).

• Marietta, Morgan, ‘The Historical Continuum of Financial Illusion’ The American Economist, Vol. 40, No. 1 (Spring, 1996), pp. 79-91.

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