VoxEU Column Financial Markets

The railway mania: Not so great expectations?

Can financial crises be averted by identifying and dealing with overpriced assets before they cause instability? This column argues that during the British Railway Mania of the 1840s, railway shares were not obviously overpriced, even at the market peak, but prices still fell dramatically. This suggests that extreme asset price reversals can be difficult to forecast and prevent ex ante, and the financial system always needs to be prepared for substantial price declines.

The instability that has followed the bursting of the housing bubble has led to a renewed discussion about what can be done to prevent the recurrence of financial crises. Cecchetti et. al (2000) have suggested that monetary policy should be tightened when regulators believe assets are overpriced, in an attempt to deflate a suspected bubble before it bursts. However, Bernanke (2002) and Mishkin (2008) have argued that this proposal is not feasible, partly because mispricing is difficult to identify ex ante. Several pieces of academic research have provided a justification for this position by suggesting that assets were not obviously mispriced prior to market crashes in certain historical episodes, such as the Tulip Mania of 1636 (Garber, 2001), the German stock market boom of 1927 (Voth, 2003), and before the Wall Street Crash of 1929 (Donaldson and Kamstra, 1996).

In a recent paper presented at the Economic History Society annual conference (Campbell, 2009a)1, I argued that an analysis of the British Railway Mania also tends to support this view. Although this period was a bubble in the popular sense of the word, in that there was a substantial asset price reversal, it was not a bubble in the economic sense, as railway shares were not obviously mispriced at the market peak2. Prices of railway shares rose by an average of 106% between 1843 and 1845, but the market then crashed, and during a prolonged decline, railway shares fell back below their original value. However, a similar rise and fall also occurred in the dividends paid by the railways. There is evidence that the railways were priced consistently with non-railways throughout the period, given the short-term dividend growth which they were experiencing, and it would have been difficult for anyone to have predicted the extent of the asset price falls that eventually transpired.

If it is not possible for regulators to effectively forecast and prevent an asset price bust, then the financial system needs to be structured in such a way that it can always withstand the worst-case scenario. It may be advisable to consider extreme stress-testing to analyse what would happen if some of history’s largest peak-to-trough asset price falls were repeated. This would imply a repeat of the recent banking stress tests on an ongoing basis, using even more pessimistic assumptions. If the system could not survive these historical scenarios then some form of tighter regulation or restructuring may be necessary.

Stock prices

To analyse the dynamics of the Railway Mania, I have constructed a unique dataset consisting of daily share prices for all 863 railway equity securities listed on the London Stock Exchange between 1843 and 1850, and weekly share price data for the twenty largest non-railway companies. This data has been used to construct several market indices that are illustrated in Figure 1.

Figure 1. Market indices for all railways, established railways and non-railways, 1843-50

The index representing all railway companies rose by 106.2% during the boom in prices, from a base of 1,000 in January 1843 to 2,062 on 6 October 1845. However, it then fell by 20.2% in just over one month, and after a brief recovery continued to decline until April 1850, to a level of just 741, which represented a fall 64.1% from its peak to its trough. The index consisting of established dividend-paying railways followed a very similar trend, rising to a peak of 1,706, before falling to a trough of 616. The index of non-railway companies was much less volatile – it never exceeded 1,182, and never fell below 879.


As can be seen from Figure 2, the average dividend of the established railways, measured as a percentage of par value,3 increased dramatically between 1843 and 1847, rising by three percentage points, or by 69.8% from its 1843 level. However, the average dividend then fell by even more than it had previously risen – 4.4 percentage points or 60.2% from its peak. The dividends paid by the non-railways remained almost unchanged during this era.

Figure 2. Railway dividends and railway share index 1843-50

Co-movements of stock prices and current dividends

In my research paper, I perform a series of econometric tests to analyse the relationship between stock prices and dividends throughout the period between 1843 and 1850. I consistently find that there was a positive and significant relationship between the dividend paid by a company and the share price at which it traded, through both the boom and bust in prices.

I have also estimated the extent to which railways may have been overpriced or underpriced, by analysing whether there was a significant difference between the dividend yields of railways and non-railways at any time. This involved performing a regression for each week of the sample using the dividend yield of a company as the dependent variable and using a dummy variable, which equalled 1 if a company was a railway, as the independent variable. The coefficient of the railway dummy in each week is plotted with ±1.96 standard errors in Figure 3.

Figure 3. Impact of railway dummy on dividend yield (from repeated weekly cross-sectional regressions)

The results suggest that the railways did have a significantly lower dividend yield than the non-railways, implying a relatively higher price, for 119 weeks between 1843 and 1846. During the downturn in prices the railways appear to have had a significantly higher dividend yield for 50 weeks between 1847 and 1850.

Stock prices and future dividends

These significant differences in the dividend yield may have been due to mispricing, or they may have reflected expectations of dividend growth. A further series of regressions confirm that the current dividend yield had a significant and negative relationship with the growth in dividends experienced over the next two to three years, suggesting that investors successfully incorporated short-term future changes in dividends into current prices.

I have also extended the analysis of the overpricing or underpricing of railway shares by including as independent variables the dividend growth that the company went on to experience during the next three years. After controlling for this growth, the apparent overpricing of the railways during the boom in prices is almost entirely eliminated. The railways appear to have had a significantly lower dividend yield, after accounting for short-term dividend growth, on just two weeks during the entire period, as shown in Figure 4.

Figure 4. Impact of railway dummy on dividend yield (from repeated weekly cross-sectional regressions, controlling for next three yearly dividend changes)

Railway shares were not obviously mispriced

These results suggest that dividends had a highly influential role in determining share prices during the Railway Mania, with there being evidence of a relationship between share prices and both current dividends and short-term dividend growth. However, investors seem to have been unable to forecast the longer-term dividend changes, and this is why prices rose and fell in the way that they did.

Investors initially embraced railway shares as dividends rose following a period of sustained economic growth and widespread fare reductions which had led to a doubling of passenger numbers. These investors seem to have been initially unable to predict the Irish Famine, or the Commercial Crisis of 1847, both of which would eventually reduce incomes and trade. They also failed to forecast the extent and unproductiveness of new railway construction, which occurred as a result of the Mania and reduced the overall profitability of the railway industry. When these threats to dividends eventually became clear, the prices of railway shares began to fall. However, during the boom in prices it would have required considerable foresight for anyone to have successfully predicted the extent of these threats, and railway shares were not obviously mispriced.

Lessons for the future

Given the experiences of recent years – a technology bubble and a housing bubble occurred within a decade – there is little reason to believe that investors in the current era have attained a greater ability to foresee future events, and this cycle of rising and then falling prices is likely to be repeated again.

Regulators may be able to effectively intervene if they have greater foresight than other market participants but, as Bernanke (2002) has argued, this is a very questionable assumption. Without perfect foresight by regulators, which would allow restrictions to be imposed only when necessary, there would have to be tighter regulation in all periods, and the costs of such restrictions would need to be carefully weighed against the potential benefits.

It may be better to focus efforts on ensuring stability when the next asset price bust does occur. More attention should be directed to the consequences of sustained declines in asset prices, as capital requirements which are based on short-term market risk may provide inadequate protection against persistent and longer-term falls. It may be useful to introduce some long-term stress testing, which would examine the consequences if the largest peak-to-trough asset price movements in history were to be repeated. If the financial system could not endure some of these historical experiences, then it may need to embrace tighter regulation or restructuring.


Bernanke, B. S. (2002). “Asset-Price 'Bubbles' and Monetary Policy”, speech delivered at the New York Chapter of the National Association for Business Economics, New York, October 15, 2002.
Campbell, G. (2009a), ‘The Railway Mania: Fundamentals of a Bubble’, presented at the Economic History Society Annual Conference, Warwick University, April 3, 2009.
Campbell, G. (2009b), ‘The Dividend Mania: Stock Prices and Dividends during the Railway Mania
Cecchetti, S.G., Genberg, H., Lipsky, J. and Wadhwani, S. (2000), Asset Prices and Central Bank Policy: Geneva Reports on the World Economy 2, Centre for Economic Policy research.
Donaldson, R.G. and Kamstra, M. (1996), "A New Dividend Forecasting Procedure that Rejects Bubbles in Asset Prices: The Case Of 1929's Stock Crash", Review of Financial Studies, pp. 333-383.
Flood, R.P. and Hodrick, R.J. (1990), ‘On Testing for Speculative Bubbles’, The Journal of Economic Perspectives, pp. 85-101.
Garber, P.M. (2001), Famous First Bubbles, the Fundamentals of Early Manias, MIT Press, Cambridge, Massachussets.
Kindleberger, C.P. (2000), Manias, Panics, and Crashes: A History of Financial Crises, John Wiley & Sons.
Mishkin, F.S. (2008), ‘How Should We Respond to Asset Price Bubbles?’ speech delivered at the Wharton Financial Institutions Center and Oliver Wyman Institute's Annual Financial Risk Roundtable, Philadelphia, Pennsylvania, May 15, 2008.
Voth, H.J. (2003), "With a Bang, not a Whimper: Pricking Germany's “Stock Market Bubble” in 1927 and the Slide into Depression", The Journal of Economic History, vol. 63, no. 01, pp. 65-99.

1 The paper presented at the Economic History Society annual conference (Campbell, 2009a) has been revised and expanded to produce Campbell (2009b).
2 Previous academic literature has generally used two definitions of a “bubble”. The popular usage of the term, per Kindleberger (2000, p.16) is an “upward price movement over an extended range that then implodes”. The economic definition of a “bubble” is a deviation from fundamental value (Flood and Hodrick, 1990, p.88).
3 The par value of a share represented the total amount of equity that shareholders had invested in that security, so the dividend/par ratio provided an estimate of the shareholders’ return on their equity investment, and was a popular method of reporting dividends.


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