Asset pricing in the early twentieth century

Most of the practical applications of finance theory have been applied to modern asset markets in developed economies. I take modern theories of asset pricing and apply them to data in the first quarter of the twentieth century. This can help us to discriminate between two competing hypotheses. First, that agents take existing theories of finance and use them to price assets traded in organized markets, thus helping to validate the theories' predictions. Second, that the finance literature developed in the second half of the twentieth century is a useful tool to explain, and predict, agents' behavior.; In Chapter 1, in joint work with Steve Juh, I take the Black-Scholes model of derivative pricing and test whether the prices of stock options and warrants, traded in South Africa in the early twentieth century, can be explained by the modern theory. I show that long before the development of the formal theory, investors had an intuitive grasp of the determinants of derivative pricing.; Chapter 2 examines the integration of world stock markets before and after World War One. I collect a unique data set of 12 developed and developing countries' stock markets over the period 1900 to 1925. I explore whether asset prices in all 12 markets can be adequately explained by a single world model that assumes world assets are all exposed to the same shocks, albeit in different degress. A single model is sufficient to explain asset returns pre-World War One, indicating stock markets were highly integrated during the last years of the Gold Standard. Market integration fell during and after the war, particularly for Germany and Austria, and to a lesser extent France. It is likely that the substantial inflation these countries experienced played a major part in this market segmentation.; In Chapter 3 of the dissertation, working with Ronnie Sadka, I test whether liquidity is an important determinant of asset returns. I use data on the stock exchanges of Madrid and Zurich between 1900 and 1925 to test whether liquidity is important to explain asset returns. Differences in the liquidity levels of assets are important to explain returns whereas an asset's sensitivity to market liquidity shocks (the market liquidity beta) and to market movements (the market return beta) are not important. This suggests that liquidity rather than systematic risk is perhaps a more fundamental determinant of asset returns.