Does Credit Affect Stock Trading? Evidence From the South Sea Bubble

Abstract

This paper identifies the mechanism through which credit fuels asset prices. On one extreme, cheap credit may reduce the cost of capital increasing prices without trading. On the other extreme, borrowers may transfer wealth to rational arbitrageurs by unsuccessfully riding a bubble. We collect every individual stock transaction for three major companies during the 1720 South Sea Bubble. We link traders’ transactions to margin loan positions and shares subscriptions. We find that margin loan holders are more likely to buy (sell) following high (low) returns. They subscribe to new issues of overvalued shares and incur large losses.

Keywords: Bubble, Credit Provision, Margin Loans, Investor Behavior

JEL Classification: G01, G12, G21, N23