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Deriving the Railway Mania

Journal: Financial History Review

Date: 20130401

Author: Campbell, Gareth

Abstract:
This article argues that the promotion boom which occurred in the railway industry during the mid 1840s was amplified by the issue of derivative-like assets, which let investors take highly leveraged positions in the shares of new railway companies. The partially paid shares which the new railway companies issued allowed investors to obtain exposure to an asset by paying only a small initial deposit. The consequence of this arrangement was that investor returns were substantially amplified, and many schemes could be financed simultaneously. However, when investors were required to make further payments it put a negative downward pressure on prices.

Link: Google Scholar

Background and Context

The Railway Mania

The British Railway Mania of the 1840s saw dramatic increases in railway share prices and extensive promotion of new railway companies, with at least 1,000 new railway lines being projected.

Research Scope

This study analyzed share price data from the London Stock Exchange between 1843-1850 to understand how partially paid shares functioned as derivative-like assets during this period.

Methodology

The research examined cointegration between fully paid and partially paid railway shares, collecting data from original newspaper tables and analyzing returns using various financial metrics.

Growth in Railway Share Values During the Mania

  • The Railway Mania saw dramatic increases in share prices between 1843-1845
  • Railway shares rose by 93.5-98.4%, while non-railway shares only increased 18.8%
  • This shows the dramatic scale of the railway investment boom

Returns on Partially vs Fully Paid Shares 1844-1847

  • Partially paid shares provided significantly higher returns than fully paid equivalents
  • 1844 authorized railways saw 57.5% returns on partially paid vs 16.6% on fully paid shares
  • The leverage effect of partially paid shares amplified investor returns

Growth in Railway Capital Requirements 1843-1850

  • Total nominal capital required increased dramatically during 1844-1845
  • Only a small fraction was initially paid up as par value
  • This structure allowed extensive railway promotion with minimal initial capital

Impact of Capital Calls on Share Prices

  • Increasing capital calls between 1846-1848 coincided with share price declines
  • Each 1% increase in par value led to 0.07-0.18% decrease in share prices
  • The deleveraging process contributed to market downturn

Number of New Railway Promotions Over Time

  • Peak of new railway promotions occurred in 1845-1846
  • Many promoted railways never received parliamentary authorization
  • Partially paid shares enabled rapid expansion of railway proposals

Contribution and Implications

  • The study demonstrates how derivative-like partially paid shares amplified both the boom and bust of the Railway Mania
  • Findings provide historical evidence that leveraged financial instruments can exacerbate asset price cycles
  • Results suggest modern policy makers should carefully monitor leverage levels in financial markets

Data Sources

  • Share Value Chart: Constructed from data in Figure 1 showing railway and non-railway share indices
  • Returns Chart: Based on Table 2 comparing returns between partially and fully paid shares
  • Capital Chart: Created using data from Figure 8 showing total par and nominal values
  • Calls Chart: Derived from Figure 9 and Table 4 regression results
  • Promotions Chart: Based on Figure 6 showing number of new railways by authorization year