Equity market run-ups (also known by the fraught term, “bubbles”) have riveted the attention of investors, asset managers, regulators, and central bankers for centuries. Commonly defined as a departure of prices from fundamental values dominated by a self-fulfilling feedback loop between expected prices and current prices, such episodes summon the conventional view that run-ups reflect market irrationality. Some run-ups preceded spectacular crashes and spawned serious economic contractions, from which new regimes of prudential regulation and pre-emption followed. Iconic examples were the Mississippi Bubble (1720), the South Sea Bubble (1720), the “Roaring Twenties” (1924–1929), and the Housing Bubble (of 2003–2008). Yet other run-ups have produced no long-lasting effects.3 Success in distinguishing malign run-ups from their benign counterparts depends on a deep understanding of their causes and dynamics.
Making use of these four propositions, we offer insights into the causes of one of the most prominent run-ups of the 19th century and then offer reflections upon their implications.
Yet why does discernment about run-ups matter? Central bankers and regulators often debate whether and how to intervene in run-ups and slumps. Household investors and professional asset managers struggle to adjust portfolios to unusual market conditions. CEOs and CFOs labor to make sense of unusual changes in their share prices in an effort to sustain efficient capital allocation. As a result, the astute official, investor, or executive should: (1) look for economic shocks that might explain the run-up; (2) assess the sufficiency and quality of information about them; and (3) ascertain which investors are trading—who is at the margin?
New research on Britain's “Railway Mania” of the 1840s by Atta-Darkua, Bruner, and Miller (2024) provides the foundation for this discussion. In 1844, British Prime Minister Robert Peel commenced a legislative reform of laws, regulations, and customs that constrained economic growth, restricted foreign trade, limited the ability of entrepreneurs to form new companies, checked the Bank of England's lending, challenged investors’ property rights, and constrained governance in the burgeoning railway industry. Altogether, Peel's initiative amounted to one of the most significant liberalizations in economic history.5 This programmatic onslaught coincided with a remarkable run-up in British railway equity prices from early 1844 to August 1845. Charles Mackay, a contemporary writer described the “mania” as the “greatest example in British history of the infatuation of the people for commercial gambling” ([1841], 1980, p. 88). Then in the fall of 1845, the run-up turned into an equity price slump, followed by a modest recovery, and then a long and deep deflation in both stock prices and economic activity. This process triggered serious civil unrest in Britain. Indeed, Karl Marx and Friedrich Engels
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