The First Stock Market — the Amsterdam Bourse — Functioning WITHOUT State Enforced Rules

It is often argued that government rule enforcement is necessary for the development of a stock market (Glaeser, Johnson, & Shleifer, 2001). Work by Boot, Stuart, and Thakor (1993), Klein and Leffler (1981), and Telser (1980), however, suggests that repeated interaction and reputation can create incentives for contracts to be self-enforcing. This paper investigates these claims by examining the first stock market, the Amsterdam Bourse. At a time when many financial contracts were unenforceable in government courts the market developed surprisingly advanced trading instruments. Descriptions by seventeenth-century stockbroker, De la Vega [Confusion de Confusiones], indicate that a reputation mechanism enabled extralegal trading of relatively sophisticated contracts including short sales, forward contracts, and options.

From stock markets in former socialist countries to new electronic trading networks in the West, there is much debate over the proper amount of oversight of financial exchanges (Frye, 2000; Macey & O’Hara, 1999). A market without rules would hardly be conducive to trade (Brennan & Buchanan, 1985) so it is often concluded that government rules and regulations are necessary for a stock market to function (Glaeser, Johnson, & Shleifer, 2001). What happens when a legal system is not equipped to deal with complicated financial transactions? Boot, Stuart, and Thakor (1993), Klein and Leffler (1981), and Telser (1980), give us theories of how contracts can take place even without external enforcement. Among other things they illustrate that repeated interaction and reputation can align incentives such that it pays to abide by one’s contracts. This paper uses evidence from the first stock market to investigate the degree to which financial markets are able to function without state enforced rules.

In the seventeenth century, the Amsterdam Bourse developed surprisingly advanced trading instruments at a time when government courts were unaccustomed and unable to deal with what today would be considered common financial transactions. Much of the dealings that took place were actually prohibited by law, although the law was ineffective and not strictly enforced. This relatively free atmosphere allowed the traders to experiment and devise new trading instruments, even though they were officially proscribed. The development of the instruments on the Amsterdam Bourse was not due to government directive but self-interest of traders who found it profitable to engage in new financial dealings. In contrast to the position that financial markets depend on government rules and regulations, the historical record lends credence to the theories that contracts can be self-enforcing and that market participants can police themselves.

—Edward Stringham, “The Extralegal Development of Securities Trading in Seventeenth-Century Amsterdam,” Quarterly Review of Economics and Finance 43, no. 2 (2003): 321-322.