Understanding financial derivatives during the South Sea Bubble: the case of the South Sea subscription shares

Abstract

South Sea Company subscription shares were compound call options on the firm's own fully-paid shares. From the description of shares found in 6 Geo.1, c.4, a theory of their pricing is developed. A method for computing subscription share values is also developed. Calculated theoretical values for subscription shares are compared to the shares' historical values and a close correspondence between the two is demonstrated. The prices of the subscriptions relative to fully-paid share prices thus appear to be explainable using simple financial economic theory and to have been formed quite rationally. There is no obvious evidence of barriers to arbitrage or inefficiencies in the markets for fully-paid shares and subscription shares during the financial crisis known as the South Sea Bubble.

Riding a wave: the Company's role in the South Sea Bubble

“…Shea, ‘Understanding financial derivatives’, pp. i75–6, believes that this provision also applied to regular money subscribers.…”

Stock prices' interdependence during the South Sea boom and bust

“…The South Sea bubble together with the Tulipmania and the Mississippi bubbles are the early bubbles that occurred during the 17th and 18th centuries (Dale, 2004). According to Shea (2007b), during the South Sea bubble along with the shares market, there was also a financial derivatives market that attracted a large number of investors. 4 The new Chartered Bank of England dominated the market activity in the 1690s with its initial subscription in 1694 and its additional capital stock in 1697 (Carlos, Fletcher, & Neal, 2015).…”

A Short History of Derivative Security Markets

“…The South Sea Company issued partially paid shares that subscribers could buy by making several installment payments. Shea (2007) maintains that these shares were compound call options because the payment of an installment gave the subscriber the right to pay the next installment, thus keeping alive the option to eventually own the share. If the share price fell below a certain value, the subscriber could refuse to make the next installment payment, forfeiting the option on the shares.…”