Risk Management in the First Emerging Markets

University Of Colorado At Boulder, Boulder CO

Investigators

Abstract

We examine in detail the responses of stock market participants before, during, and after the first great financial crisis of modern capitalism - the South Sea Bubble of 1720. We exploit data we have collected and will collect on the holdings and transfers of the major financial assets available in the London market among all individuals who held these assets before, during, and after the crisis of 1720. Our analysis of the changes that took place in the distribution of these assets, especially in the period 1721 to 1730, will be an intensive examination of the reallocation of financial risk by participants during the first crisis of financial capitalism. Additional data on the tax assessments of London residents and their voting behavior in the Parliamentary election of 1722 will be utilized to compare how different types of investors shifted their financial portfolios after the bubble's collapse. This will allow us to explore the factors that enabled the underlying structures of the English financial system to absorb the shock of a stock market collapse and then rebound, based largely on the private initiatives of these participants. The conjunction of financial innovations, new participants in the markets for financial assets, and experimental political regimes in the first quarter of the 18th century provides a natural laboratory in which many of the alternative approaches now being attempted in today's emerging markets can be examined. Alone among the first emerging stock markets of the time, the London market was able to survive the shock of the collapse of stock prices, which gives special significance to our study of individual behavior during this episode. Further, it is our working hypothesis that the development of this market, especially focused on the liquidity of financial instruments congenial to the needs of the market participants for managing their individual exposures to risk, may have given the impetus to private investment that eventually made Britain the first industrial nation and the dominant economy of the world by the end of the nineteenth century.