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Speculation, Trading, and Bubbles
I discuss some evidence for the assumption of costly shortselling and for the role of overconfidence in generating differences in beliefs. Section 4 presents an informal sketch of the model and a discussion of related issues such as the effect of leverage, the origin of optimism, and the role of corporations in sustaining bubbles. I summarize some empirical work that provides evidence for the model in section 5 and present some concluding thoughts in section 6. A formal model is exposited in the appendix.
1 An Ex mple: The South Sea Bubble One of the earliest well-documented occurrences of a bubble was the extraordinary rise and fall of the prices of shares of the South Sea Company and other similar joint-stock companies in Great Britain in 1720. At its origins in 1710, the South Sea Company had been granted a monopoly to trade with Spain’s South American colonies. However, during most of the early eighteenth century Great Britain was at war with Spain’s Philip V and the South Sea Company never did much goods-trading with South America, although it did achieve limited success as a slave trader. The real business of the South Sea Company was to exchange its stock for British government debt. The new equity owners would receive a liquid share with the right to perpetual annual interest payments in exchange for government debt, which paid a higher interest rate but was difficult to trade. In the first months of 1720, the Company and its rival, the Bank of England, engaged in a competition for the right to acquire n
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