Asset BubblesHow Much is That Doggie in the Window Really Worth?<br />
Ordinary Tulips<br />Tulips originated in Turkey and became an exotic oriental flower to European elites in the seventeenth century.<br />Ordinary Tulips are of a solid colour<br />They propagate most rapidly asexually by the splitting or budding or their bulbs<br />Bulbs will mature in two to three years<br />Flowers grown from seeds mature in seven to twelve years.<br />They flower in June and then must be dug up to be replanted in September<br />
Extraordinary Tulips<br />A mosaic virus can infect or break bulbs<br />The resultant mutations can result in flowers of varied and sometimes spectacular colours<br />It is ironically these broken bulbs and there mutant breeding strains that became the focus of tulip speculation<br />
Tulips for the Lady<br />The ultimate market for the flowers was the ballrooms of France<br />Baths were not frequent and ladies took to wearing not only perfume but adorning the bodice of their dress with fresh flowers<br />No woman wants to go to the ball wearing either the same dress or the same flower as another lady<br />Gentlemen in Paris would pay a thousand guilders for the right flower. <br />
A Scarce Commodity<br />Thus extraordinary tulip flower became a valuable commodity<br />Because they by nature mutant accidents of nature <br />And took a relatively long period of time to grow in volume because<br /> of the long maturing period for seeds<br />And of the relatively few bulb buds if reproduced asexually<br />The fashion demand of Paris drove up prices<br />
A Natural Futures Contract<br />Middle men had an eight month period between Sept & June to place the order for future delivery<br />This made a natural futures contract<br />As we now realize any derivative is essentially equivalent to borrowing the money current to buy a commodity.<br /> Thus the Black Scholes model its value is a function of the risk free interest rate and the volatility of the underlying commodity price. <br />The point here is that the futures contract provided speculators instant credit for the future purchase of tulips.<br />
SPECUALTORS<br />Between 1634 and 1637 the clubby caste of Dutch flower growers was invaded by speculators<br />The large profits from the Paris market attracted what we would call today arbitragers intent on capturing the profit between the grower and the Paris market<br />A nascent stock market in the Dutch Joint Venture Companies provided the model<br />Taverns became trading floors<br />The futures contract was verbal<br />The Option price was wine money<br />
The Elements of an Asset Bubble<br />Scarce Commodity<br />Rapid expansion of money or credit<br />Moral Hazard<br />Playing with very little of your own money and a lot of someone else's<br />You don't have a lot to use<br />
1637 the Collapse<br />The rapid expansion of credit inherent in the futures contracts seem to have driven up the prices between 1634 - 1636.<br />In 1636 an extra ingredient was added to the brew of Moral Hazard.<br />The plague struck a number of Dutch communities and there may have been some correlation between the highest levels of speculation and plague outbreak<br />By February 1637 individual cities were setting the terms to pay forfeiture fees of 3-4% to allow contract cancellations and allow growers to resell on the open market<br />
Lessons Learned<br />The traditional lesson handed down to us is that people are<br />irrational<br />speculation is immoral<br />The facts indicate perhaps something different<br />There is no indication that the actual price or value of the final market in tulip bulbs collapsed<br />There was little legal structure to the tulip contact market<br />Speculation in contract over about a two month period in Jan-Feb of 1637 led to wide price fluctuations<br />Individual municipalities had to intervene to allow the orderly cancellation of contracts to allow growers to sell on the open market in June<br />
Morality or Self Interest<br />Prices go up until they come down.<br />Tulips were intrinsically valuable and the prices did not get too high until the last month or two before the collapse in the futures market<br />Is the moral indignation of the Dutch commentators justified<br />Or is it the self interested comments of growers who want to keep arbitragers out of their monopolistic and highly profitable market<br />How much would you spend on that girl?<br />How much would you spend on house?<br />
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