A comparative study of capital market failure and institutional innovation

Abstract

Comprised of two separate projects, this study examines imperfections in early capital markets. The first concerns the insurance benefits associated with the scattered landholdings of medieval peasant farmers while the second traces the evolution of securities markets in the United States. In particular, the second focuses on both the development of the New York Stock Exchange and the role of the London Stock Exchange in channeling capital to U.S. firms. Previous research suggests that scattered holdings may have reduced variation in annual agricultural yields. The argument hinges on the notion that yields were not too highly correlated on separate plots of land within the same village. To this point, however, researchers have lacked the sort of data necessary to adequately test this hypothesis. Tithe records from two villages in northern France-Onnaing and Quarouble-provide the basis for constructing a time series of financial returns on individual plots of land. Using these returns, a portfolio analysis is undertaken to measure the reduction in yield variances associated with scattering. The results suggest that it was crop diversification, not scattering, that provided insurance benefits to peasant farmers. In the second project, data from the London Stock Exchange indicate that, in the nineteenth and early twentieth centuries, British capital funded many ventures in the emerging American West. Many of these ventures, moreover, were not able to attract finance through the aegis of the premier domestic capital market- the New York Stock Exchange. Financial data from a number of stock exchanges- most notably the New York, the London, and the Boston-and institutional descriptions drawn from various published sources, suggest that, in an effort to relieve uncertainty and establish wider markets for their securities, the Governors of the New York exchange developed a set of trading rules and vetting procedures which excluded securities from small new companies. Not surprisingly, these firms were often located in the West.