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CRIEFF Discussion Papers list Abstract
We present evidence of
rational pricing South Sea Company liabilities and call options written on South
Sea shares. A previously unstudied dataset on South Sea share options is
presented. The Company's capital structure of the firm is redefined so that the
application of modern financial economic theories can be applied to its
valuation. We present evidence that a significant portion of South Sea equity
liabilities was in the form of share warrants and conversion (from bonds to
shares) privileges and should be so valued. Finally we present a model of the
cross-sectional behaviour of share prices, South Sea Company debt and call
option values. The model is calibrated and simulated in order to produce
estimates of the required return on the Company’s debt and the volatility of the
firm’s asset values. We conclude that the jointly estimated value of the firm,
its constituent liabilities, third-party call option values and implied
volatilities are consonant with rational pricing behaviour during the Bubble,
although the model requires extension in several directions in order to present
a more complete picture of the South Sea Bubble.
Key Words
financial revolution in England, South Sea Company, call
options, warrants, convertible bonds
JEL Classifications: N23, G13
Gary S. Shea
University of St Andrews
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CRIEFF Discussion Papers list