Credit Provision and Stock Trading: Evidence From the South Sea Bubble

Abstract

This paper studies the mechanisms that relate credit provision to asset prices. Credit provision may affect prices via various channels with different implications for trading behavior, loan defaults and realized returns. We collect every stock transaction for three major British companies during the 1720 South Sea Bubble. We find that loan holders are more likely to buy following high returns. Loan holders also subscribe to overvalued stocks and incur large trading losses. We find evidence of extrapolating investors self-selecting into a credit facility. We also document that moral hazard leads to increased risk taking and larger losses.

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

JEL Classification: G01, G12, G21, N23