Re: Can Tulipmania be explained rationally as the birth of options?
to be honest, not a lot. I'm trying to track down the actual working paper, but my immediate reaction is the same as my reaction to Peter Garber's previous attempt to interpret tulipomania as a rational phenomenon, and rather similar to your own; it is a historical fact that tulipomania diverted massive amounts of the productive output of the Dutch economy and led to a serious recession. If this was produced as the result of the operation of an efficient market, then any point one might reasonably want to make as a critique of efficient markets theory is made, and the Chicago boys have saved their theory by destroying it. In any case, I don't think it makes sense as a piece of finance theory; the option tail does not wag the spot dog. If the reinterpretation of the contracts did take place in this manner, then that would make the futures/options contracts themselves much more valuable to the buyers, but it would make no sense at all for the sellers of tulip bulbs to mark up the spot price of tulips. I suspect that the authors are relying on the assumption that it would be possible for an investor to go short of physical tulips, something which I do not believe was possible. dd -Original Message- From: PEN-L list [mailto:[EMAIL PROTECTED] Behalf Of Michael Pollak Sent: 17 July 2004 20:29 To: [EMAIL PROTECTED] Subject: Can Tulipmania be explained rationally as the birth of options? [Does this argument make any sense? I can't see any upside for the planters in this arrangment. It seems they would be better off doing all their deals on the spot market. And it doesn't seem to provide any explanation for the collapse. It seems they are just in love with the ratio and are bending the facts to fit their chosen conclusion. I was wondering if people who know more about option pricing might see merits that I'm missing.] URL: http://slate.msn.com/id/2103985/ moneyboxDaily commentary about business and finance. Bulb Bubble Trouble That Dutch tulip bubble wasn't so crazy after all. By Daniel Gross Posted Friday, July 16, 2004, at 2:05 PM PT During the dot.com bubble and its collapse, economists and historians increased their study of market crazes of the past, particularly the most ludicrous one of all: the 17^th-century Dutch flower bubble. The classic description of Tulipmania appeared in Clarence Mackay's 1841 classic Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, In 1634, the rage among the Dutch to possess them was so great that the ordinary industry of the country was neglected, and the population, even to its lowest dregs, embarked in the tulip trade. The normally sane Dutch bourgeoisie got carried away and bid up prices of tulip bulbs spectacularly in winter 1637, only to see them crash in spring. One bulb was reportedly sold in February 1637 for 6,700 guilders, as much as a house on Amsterdam's smartest canal, including coach and garden, and many times the 150-guilder average income. As Earl A. Thompson, an economist at the University of California at Los Angeles, and Jonathan Treussard, a graduate student at Boston University, note in a working paper, the contract price of tulips in early February 1637 reached a level that was about 20 times higher than in both early November 1636 and early May 1637. Sounds like a bubble. But it wasn't, asserts Thompson, who is working on a history of bubbles. Tulip-bulb investors were neither mad nor delusional in 1636 and 1637. Rather, he says, they were rationally responding, in finest efficient-market fashion, to overlooked changes in the rules of tulip investing. As European prices for the dramatic flowers rose in the 1630s, many burgomasters--local mayors--started to invest in the bulbs. But in the fall of 1636, the European tulip market suddenly wilted because of a crisis in Germany. German nobles were big fans of tulips and had taken to planting bulbs. But in October 1636, the Germans lost a battle to the Swedes at Wittstock. Then German peasants began to revolt. The German demand for tulips sagged, and princes began digging up their own bulbs and selling them, say Thompson and Treussard. The sudden glut caused prices to fall, and Dutch burgomasters began losing money. They were in a bind. Trade in tulip bulbs was conducted through futures contracts: Buyers agreed to pay a fixed price for tulip bulbs at some point in the future. With prices having fallen in the fall, leveraged burgomasters were tied into paying above-market prices for bulbs to be delivered in the spring. Rather than take their lumps, these politically connected investors tried to change the market rules--and they succeeded. First, they threatened to abandon their contracts and leave planters in the lurch entirely. But ultimately, they ironed out a deal
Re: Can Tulipmania be explained rationally as the birth of options?
First of all, great pun: spot dog. The person whom Daniel mentions, Garber, is an economist, who began to write about tulip mania right after the `987 stock market melt down in the vain hope of proving that markets were efficient. In the end, he admitted some irrationality, but not a lot. Michael Perelman Economics Department California State University Chico, CA 95929 -Original Message- From: PEN-L list [mailto:[EMAIL PROTECTED] On Behalf Of Daniel Davies Sent: Sunday, July 18, 2004 4:26 AM To: [EMAIL PROTECTED] Subject: Re: [PEN-L] Can Tulipmania be explained rationally as the birth of options? to be honest, not a lot. I'm trying to track down the actual working paper, but my immediate reaction is the same as my reaction to Peter Garber's previous attempt to interpret tulipomania as a rational phenomenon, and rather similar to your own; it is a historical fact that tulipomania diverted massive amounts of the productive output of the Dutch economy and led to a serious recession. If this was produced as the result of the operation of an efficient market, then any point one might reasonably want to make as a critique of efficient markets theory is made, and the Chicago boys have saved their theory by destroying it. In any case, I don't think it makes sense as a piece of finance theory; the option tail does not wag the spot dog. If the reinterpretation of the contracts did take place in this manner, then that would make the futures/options contracts themselves much more valuable to the buyers, but it would make no sense at all for the sellers of tulip bulbs to mark up the spot price of tulips. I suspect that the authors are relying on the assumption that it would be possible for an investor to go short of physical tulips, something which I do not believe was possible. dd -Original Message- From: PEN-L list [mailto:[EMAIL PROTECTED] Behalf Of Michael Pollak Sent: 17 July 2004 20:29 To: [EMAIL PROTECTED] Subject: Can Tulipmania be explained rationally as the birth of options? [Does this argument make any sense? I can't see any upside for the planters in this arrangment. It seems they would be better off doing all their deals on the spot market. And it doesn't seem to provide any explanation for the collapse. It seems they are just in love with the ratio and are bending the facts to fit their chosen conclusion. I was wondering if people who know more about option pricing might see merits that I'm missing.] URL: http://slate.msn.com/id/2103985/ moneyboxDaily commentary about business and finance. Bulb Bubble Trouble That Dutch tulip bubble wasn't so crazy after all. By Daniel Gross Posted Friday, July 16, 2004, at 2:05 PM PT During the dot.com bubble and its collapse, economists and historians increased their study of market crazes of the past, particularly the most ludicrous one of all: the 17^th-century Dutch flower bubble. The classic description of Tulipmania appeared in Clarence Mackay's 1841 classic Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, In 1634, the rage among the Dutch to possess them was so great that the ordinary industry of the country was neglected, and the population, even to its lowest dregs, embarked in the tulip trade. The normally sane Dutch bourgeoisie got carried away and bid up prices of tulip bulbs spectacularly in winter 1637, only to see them crash in spring. One bulb was reportedly sold in February 1637 for 6,700 guilders, as much as a house on Amsterdam's smartest canal, including coach and garden, and many times the 150-guilder average income. As Earl A. Thompson, an economist at the University of California at Los Angeles, and Jonathan Treussard, a graduate student at Boston University, note in a working paper, the contract price of tulips in early February 1637 reached a level that was about 20 times higher than in both early November 1636 and early May 1637. Sounds like a bubble. But it wasn't, asserts Thompson, who is working on a history of bubbles. Tulip-bulb investors were neither mad nor delusional in 1636 and 1637. Rather, he says, they were rationally responding, in finest efficient-market fashion, to overlooked changes in the rules of tulip investing. As European prices for the dramatic flowers rose in the 1630s, many burgomasters--local mayors--started to invest in the bulbs. But in the fall of 1636, the European tulip market suddenly wilted because of a crisis in Germany. German nobles were big fans of tulips and had taken to planting bulbs. But in October 1636, the Germans lost a battle to the Swedes at Wittstock. Then German peasants began to revolt. The German demand for tulips sagged, and princes began digging up their own bulbs and selling them, say Thompson and Treussard. The sudden glut caused prices to fall, and Dutch burgomasters began
Re: Can Tulipmania be explained rationally as the birth of options?
First of all, great pun: spot dog. I'm so glad you spotted it. In which spirit I would like to share with an unwilling internet my son's first contribution to world literature, in the form of a story he told me yesterday. Once upon a time there was a little boy called Spot the Dog. Now go to sleep. by Joe Read age 2 1/2 best, dd
Can Tulipmania be explained rationally as the birth of options?
[Does this argument make any sense? I can't see any upside for the planters in this arrangment. It seems they would be better off doing all their deals on the spot market. And it doesn't seem to provide any explanation for the collapse. It seems they are just in love with the ratio and are bending the facts to fit their chosen conclusion. I was wondering if people who know more about option pricing might see merits that I'm missing.] URL: http://slate.msn.com/id/2103985/ moneyboxDaily commentary about business and finance. Bulb Bubble Trouble That Dutch tulip bubble wasn't so crazy after all. By Daniel Gross Posted Friday, July 16, 2004, at 2:05 PM PT During the dot.com bubble and its collapse, economists and historians increased their study of market crazes of the past, particularly the most ludicrous one of all: the 17^th-century Dutch flower bubble. The classic description of Tulipmania appeared in Clarence Mackay's 1841 classic Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, In 1634, the rage among the Dutch to possess them was so great that the ordinary industry of the country was neglected, and the population, even to its lowest dregs, embarked in the tulip trade. The normally sane Dutch bourgeoisie got carried away and bid up prices of tulip bulbs spectacularly in winter 1637, only to see them crash in spring. One bulb was reportedly sold in February 1637 for 6,700 guilders, as much as a house on Amsterdam's smartest canal, including coach and garden, and many times the 150-guilder average income. As Earl A. Thompson, an economist at the University of California at Los Angeles, and Jonathan Treussard, a graduate student at Boston University, note in a working paper, the contract price of tulips in early February 1637 reached a level that was about 20 times higher than in both early November 1636 and early May 1637. Sounds like a bubble. But it wasn't, asserts Thompson, who is working on a history of bubbles. Tulip-bulb investors were neither mad nor delusional in 1636 and 1637. Rather, he says, they were rationally responding, in finest efficient-market fashion, to overlooked changes in the rules of tulip investing. As European prices for the dramatic flowers rose in the 1630s, many burgomasters--local mayors--started to invest in the bulbs. But in the fall of 1636, the European tulip market suddenly wilted because of a crisis in Germany. German nobles were big fans of tulips and had taken to planting bulbs. But in October 1636, the Germans lost a battle to the Swedes at Wittstock. Then German peasants began to revolt. The German demand for tulips sagged, and princes began digging up their own bulbs and selling them, say Thompson and Treussard. The sudden glut caused prices to fall, and Dutch burgomasters began losing money. They were in a bind. Trade in tulip bulbs was conducted through futures contracts: Buyers agreed to pay a fixed price for tulip bulbs at some point in the future. With prices having fallen in the fall, leveraged burgomasters were tied into paying above-market prices for bulbs to be delivered in the spring. Rather than take their lumps, these politically connected investors tried to change the market rules--and they succeeded. First, they threatened to abandon their contracts and leave planters in the lurch entirely. But ultimately, they ironed out a deal whereby the obligation to purchase bulbs at a fixed price would be suddenly converted into an opportunity to do so. In current parlance, they aimed to transform tulip-bulb futures contracts into tulip-bulb options. Under the new deal, the investors wouldn't have to pay the high contract prices in the spring unless the future market--or spot--prices of tulip bulbs were higher. (To compensate the planters in case market prices were lower than the contract prices, the investors agreed to pay a small fraction of the contract price to get out of the contract, Thompson and Treussard note. Ultimately, that amounted to about 3 cents on the dollar.) On Feb. 24, 1637, the Dutch florists announced that all futures contracts written since November 30, 1636 and up until the opening of the spring season, were to be interpreted as option contracts, Thompson and Treussard write. The action was later ratified by the Dutch legislature. The news of these discussions began to filter out into the market in November 1636. Now, when it becomes clear that a contract is to be transformed into an option--the ability to buy something rather than the responsibility to do so--you would expect prices to rise. Why? If the investors in existing future contracts were only going to have to pay a small percentage of the contract price in the end--as was becoming apparent--then tulip planters would have to jack up contract
