The Tulip Mania of 1636
This article written by Akshit Gupta (ESSEC Business School, Grande Ecole Program – Master in Management, 2022) analyzes the Tulip Mania.
Introduction
The Tulip Mania or commonly referred to as The Tulip Craze is an event that took place in Northern Netherlands in the first half of the 17th century wherein the prices of bulb of tulips skyrocketed, giving rise to a speculative bubble, and crashed all of a sudden affecting the entire Dutch economy. The first evidence on the occurrence of this mania was presented by Charles Mackay in his book Extraordinary Popular Delusions And The Madness of Crowds released in 1841. Tulips were introduced in the Netherlands during the 1590s and were primarily imported from Turkey. Initially, the buds were so rare that it became an item of luxury and only affluent people were able to procure it. It soon became a status symbol among the rich people with new demand arising from the middle-class merchants to match the upper-class status. With professional cultivators coming in the early 17th century, new techniques were evolved to grow tulips in the home soil, thereby establishing a booming business sector.
The Tulip Mania
Before 1635, the exchange of tulip bulbs was restricted between the professional growers and affluent richer class but sooner the ordinary people started demanding these luxuries. The local cultivation of the flower leads to the evolution of a new variety of buds named ‘broken bulb’ which is believed to be the primary catalyst resulting in exorbitantly high prices of tulips and the creation of the speculative bubble. Middle-class people started spending their annual salaries to buy these rare bulbs in expectation of selling it for a higher profit.
The rare tulip bulbs are believed to be priced at six times the annual salary of an average person at the peak of the crisis. Assets were kept as mortgages to buy rights for these rare bulbs and later sell it at a higher price. However, the craze wasn’t long sustained as within a year people started doubting the extremely high prices, and within a matter of a few days, the entire structure crashed leading to an economic downturn. Many ordinary people have been believed to go bankrupt, deprived of their entire fortunes. The Tulip Crisis is regarded as the first such financial bubble which has happened to exist in the recorded history.
Relevance to the SimTrade course
The lesson learnt from such a crisis very well blends with the courses taught in the SimTrade course. A speculative bubble comes into existence when the market behavior drives up the asset prices exorbitantly and the fundamentals of an asset nowhere match such an upsurge. The crisis teaches us the pivotal role demand and supply play in bringing volatility to the markets. In the tulip craze, the intrinsic value of the commodity is no way near the market price for such trades. To invest wisely, an investor has to take into consideration the intrinsic or fair value of an asset in order to stay away from such bubbles that come into existence time and again. The concepts of value investing as proposed by Benjamin Graham should always be practiced to select a winning trade.
Related posts about extreme value theory
▶ Shengyu ZHENG Extreme Value Theory: the Block-Maxima approach and the Peak-Over-Threshold approach
▶ Gabriel FILJA Application de la théorie des valeurs extrêmes en finance de marchés
Useful resources
About the author
Article written by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2022).