Alternative Academic Thinking...

Kindleberger (1978) argues the Mississippi bubble was “fuelled by monetary expansion in France that supported a high head of speculative steam”.He claims that the Mississippi Bubble follows his own thesis that “most price bubbles are international disturbances transmitted among two or more centres that lead to irrational and overzealous trading in each” (Kindleberger, 1978).  You can read more about kindleberger here.

 His theory is backed up by the exchange rate evidence presented by Neal and Schubert (1985). They find the existence of speculative bubbles in the prices of Mississippi stock. This is concluded from the “relative stability of dividends actually paid out compared to the volatility of the stock prices”. However Flood and Garber (1982) argue that the price movements could also be explained through changes in the market fundamentals.

 Neal and Schubert (1985) believe that portions of the Mississippi Bubble could actually be described as a rational bubble. However they agree that it is just as likely that is the result of manipulation of market fundamentals. Neal and Schubert (1985) note that rational bubbles seem to appear when there is two distinct sets of investors who co-exist for a brief period of time. These investors may be differentiated by many things including the quality of the information they hold, their attitude toward risk, or maybe even by their time horizons. The two sets of investors work in the same way but, importantly, at different points in time, leaving their unique mark on the stock prices, but only in certain time periods.
 
The theoretical literature of bubbles states that a bubble occurs “when the expected rate of change in the price of an asset is an important factor in determining the current market price” (Neal and Schubert, 1985). It is clear that in France during 1719 and 1970 the asset prices changed enough to alter the expectations of investors. Neal and Schubert (1985) believe the real question is whether the Mississippi Bubble can be considered to be rational or not.

 Neal and Schubert (1985) present an equation to calculate the returns. You can see the full article here. They describe how investors see a capital gain above the market fundamental if the bubble continues or a return to zero gain if the bubble bursts. Therefore longer the bubble lasts the higher the capital gain must be to compensate for the increasing chances of a crash.

 According to Tirole (1982), a rational bubble must meet two further terms. Firstly, expectations must be myopic i.e. successive traders must only use the expected trading options in this period and the next to make their decisions. Secondly, there must be several ‘generations’ of traders entering the market. Both of these terms were present in the Mississippi Bubble so was it a rational bubble or not?

 Neal and Schubert (1985) conclude that although the bubble may have had significant periods of rationality, these did not coincide or even overlap.

 
Bibliography:

Flood, R. P., & P.M. Garber (1982) Bubbles, Runs and Gold Monetization, in Paul Wachtel, ed., Crises in the Economic and Financial Structure, Lexington books, Lexington, Massachusetts.

 Kindleberger, C. P., (1978) Manias, Panics, and Crashes, New York: Basic Books.

 Neal L. & E. Schubert (1985) “The First Rational Bubbles: A New Look at the Mississippi and South Sea Schemes”.Working Paper No. 1188.

 Tirole, J., (1982) "On the Possibiblity of Speculation Under Rational Expectations", Econometrica, 50, pp. 1163-1181.