Elsevier

Journal of Corporate Finance

Volume 27, August 2014, Pages 116-132
Journal of Corporate Finance

The stock market speaks: How Dr. Alchian learned to build the bomb

https://doi.org/10.1016/j.jcorpfin.2014.05.002Get rights and content

Highlights

  • Armen Alchian pioneered the event study while working at RAND in 1954.

  • Alchian determined the fissile fuel of H-bombs through stock prices.

  • Castle Bravo used lithium fuel and the main producer saw a return of 461% in 1954.

  • This paper recreates Alchian's confiscated and destroyed RAND paper.

Abstract

At RAND in 1954, Armen A. Alchian conducted the world's first event study to infer the fuel material used in the manufacturing of the newly-developed hydrogen bomb. Successfully identifying lithium as the fusion fuel using only publicly available financial data, the paper was seen as a threat to national security and was immediately confiscated and destroyed. The bomb's construction being secret at the time but having since been partially declassified, the nuclear tests of the early 1950s provide an opportunity to observe market efficiency through the dissemination of private information as it becomes public. I replicate Alchian's event study of capital market reactions to the Operation Castle series of nuclear detonations in the Marshall Islands, beginning with the Bravo shot on March 1, 1954 at Bikini Atoll which remains the largest nuclear detonation in US history, confirming Alchian's results. The Operation Castle tests pioneered the use of lithium deuteride dry fuel which paved the way for the development of high yield nuclear weapons deliverable by aircraft. I find significant upward movement in the price of Lithium Corp. relative to the other corporations and to DJIA in March 1954; within three weeks of Castle Bravo the stock was up 48% before settling down to a monthly return of 28% despite secrecy, scientific uncertainty, and public confusion surrounding the test; the company saw a return of 461% for the year.

Introduction

Fifteen years before Fama conducted “the original event study” in 1969 (Fama, 1991 pg. 1599), Armen A. Alchian was pioneering financial event studies in his spare time. In this paper I reconstruct a confiscated and destroyed event study of the Castle Bravo nuclear test conducted by Alchian at RAND in 1954. This event is chosen because of the historical importance it holds as one of the world's earliest event studies, and due to the subsequent declassification of top secret information surrounding the test it also provides an excellent case study of market efficiency. Realizing that positive developments in the testing and mass production of the two-stage thermonuclear (hydrogen) bomb would boost future cash flows and thus market capitalizations of the relevant companies, Alchian used stock prices of publicly traded industrial corporations to infer the secret fuel component in the device in a paper titled “The Stock Market Speaks.” Alchian (2000) relates the story in an interview:

We knew they were developing this H-bomb, but we wanted to know, what's in it? What's the fissile material? Well there's thorium, thallium, beryllium, and something else, and we asked Herman Kahn and he said, ‘Can't tell you’… I said, ‘I'll find out’, so I went down to the RAND library and had them get for me the US Government's Dept. of Commerce Yearbook which has items on every industry by product, so I went through and looked up thorium, who makes it, looked up beryllium, who makes it, looked them all up, took me about 10 minutes to do it, and got them. There were about five companies, five of these things, and then I called Dean Witter… they had the names of the companies also making these things, ‘Look up for me the price of these companies…’ and here were these four or five stocks going like this, and then about, I think it was September, this was now around October, one of them started to go like that, from $2 to around $10, the rest were going like this, so I thought ‘Well, that's interesting’… I wrote it up and distributed it around the social science group the next day. I got a phone call from the head of RAND calling me in, nice guy, knew him well, he said ‘Armen, we've got to suppress this’… I said ‘Yes, sir’, and I took it and put it away, and that was the first event study. Anyway, it made my reputation among a lot of the engineers at RAND.

Alchian's study using only public information to successfully identify the fuel material of a secret US nuclear bomb test provides powerful evidence in favor of market efficiency; it was public information that the US was conducting atomic bomb tests, but it was not publicly known at the time how the bombs were constructed and even for top scientists working on the bomb, it was purely speculative what the best fusion fuel for hydrogen bombs would turn out to be. A timeline of notable dates in the secret development of lithium fuel as well as public information on lithium appearing in the media is found in Table 1. This original event study is a testament to Alchian's great contributions to economic thought; unfortunately, his work was so insightful that the paper was suppressed and is now lost and largely forgotten. Alchian (2006, pg. xxv–xxvi) provides some additional information on the relevant test:

The year before the H-bomb was successfully created, we in the economics division at RAND were curious as to what the essential metal was—lithium, beryllium, thorium, or some other… For the last six months of the year prior to the successful test of the bomb, I traced the stock prices of those firms. I used no inside information. Lo and behold! One firm's stock price rose, as best I can recall, from about $2 or $3 per share in August to about $13 per share in December. It was the Lithium Corp of America. In January I wrote and circulated [the memorandum]. Two days later I was told to withdraw it. The bomb was tested successfully in February, and thereafter the stock price stabilized.

The first hydrogen bomb test, Mike shot of Operation Ivy on November 1, 1952, used liquid deuterium as its fuel. The purpose of Operation Ivy was to upgrade the US nuclear arsenal from atomic bombs to much more powerful hydrogen bombs. After Operation Ivy which involved a total of two tests, both in November 1952, Operation Upshot–Knothole followed with eleven detonations in Nevada between March and June 1953. The purpose of these tests was hydrogen bomb component development, measuring the effects of fallout and radiation, and the testing of the effects of nuclear artillery. Shot Ruth, the third of eleven tests in Upshot–Knothole, was detonated on March 31 and tested a bomb made with uranium hydride — it fizzled. The fifth test, Shot Ray, tested a device made of uranium deuteride on April 11 and also fizzled. The failures of both Ruth and Ray demonstrate the difficulties engineers faced in the development and testing of nuclear weaponry, especially in the early days with the uncertainty regarding the effectiveness of various radioactive materials available. The last, Shot Climax, was detonated on June 4, 1953 and tested the MK 7 primary detonator to be used in the two-stage weapons of Operation Castle. Climax was followed by Operation Castle – the first series of hydrogen bomb tests to make use of lithium fuel – with seven detonations from March 1 (February 28, local time) to April 22, 1954 in the Marshall Islands. At the time, scientists had only publicly speculated on the usefulness of lithium in the development of the hydrogen bomb; the Castle tests were the first to experiment with what were only theoretical uses of lithium fuel, though the public was not aware of this experimentation due to the secrecy surrounding nuclear development. The first of these tests, Castle Bravo, was the first American test of a dry fuel thermonuclear bomb, using lithium deuteride instead of the cryogenic liquid fuel of previous tests. It was a great success and remains the largest detonation in US history, yielding 15 megatons, about 1000 x the power of Little Boy or Fat Man. The lithium deuteride fuel generated an unexpected boost to the yield and Castle Bravo exceeded the predicted energy output by 150%, paving the way for powerful yet practical aircraft-deliverable weapons. It was so unexpectedly powerful that U.S. servicemen and Japanese fishermen who were thought to be at a safe distance from the test were dusted with fallout. The press reported on the destructive power of the bomb after a lag of several days, but mistakenly reported that it was an atomic rather than hydrogen bomb, illustrating the secrecy and lack of public information that surrounded the tests. The Bravo test was followed by Romeo on March 26 with fusion fuel composed of 7.5% lithium. It exceeded its expected energy by a factor of 3, yielding 11 megatons. Shot Echo, which had been scheduled for March 29, was canceled after the success of Bravo rendered cryogenic fuel bombs obsolete. The next shot, codenamed Koon, was run on April 6 but fizzled due to a design defect, and was followed by Union on April 25. Union used highly enriched lithium fuel and was a success, yielding 6.9 megatons. This was followed by Yankee II on May 5 with 40% partially enriched lithium fuel, doubling expected yield with 13.5 megatons, the second most powerful test in US history. Operation Castle concluded with Nectar on May 3 consisting of uranium and plutonium with a lithium booster. Given its importance, its timing, and its fuel source, Castle Bravo is the most likely subject of Alchian's suppressed paper. The following batch of tests called Operation Teapot were run from Feb 18 to May 15, 1955 and included 14 small 1 to 30 kiloton tests, but their purpose was to improve nuclear battlefield tactics, not bomb manufacturing.

The efficient market hypothesis holds that prices are “accurate,” that they reflect all available information (Fama et al., 1969). As a test of market efficiency, several questions must be addressed surrounding Castle Bravo. First, to what extent was the Operation Castle test series kept secret before and after the tests, and how quickly and in what manner was the information surrounding the tests disseminated to the public? French and Roll (1986) observe that most information falls in a continuum between public and private, and Maloney and Mulherin (2003) and Maloney and Mitchell (1989) provide evidence that the stock market reflects secret or unknown information in the price discovery process. Operation Castle clearly entailed both public and private information components. Second, to what extent did the public understand the importance of lithium fuel in advancing the development of small high-yield thermonuclear weapons? Were there any unexpected positive developments regarding the use of lithium for commercial purposes that could have driven Lithium Corp.'s price upward in the time immediately preceding and subsequent to the successful Castle tests? As I demonstrate below, while stories mentioning lithium appearing in the New York Times or Wall Street Journal throughout 1953–1954 were consistent with a positive outlook for the lithium market, there were no sudden positive changes that alone would seem to explain very large increases in the valuation of Lithium Corp. in the months surrounding Operation Castle.

Using daily closing bids of major publicly traded manufacturers of fuel producers I find significant upward movement in the price of Lithium Corp. stock relative to other metal-producing corporations and to the Dow Jones Industrial Average (DJIA) in March 1954; within three weeks of Castle Bravo the stock was up 48% before settling down to a monthly return of 28% despite secrecy and public confusion surrounding the test. This greatly outperformed the other stock returns for the same month and the DJIA which saw an increase of 2.3% for the month. The price of Lithium Corp. continued to rise for the remainder of 1954 and saw a return of 461% for the year, some of which was gained in the two months leading up to the test despite little price movement in the twelve months prior. Lithium Corp. was seemingly singled out not only in the lead-up to the test, suggesting insider information, but after the successful test as well, suggesting successful dissemination of information relevant to the value of Lithium Corp. in the weeks and months following Operation Castle's success.

The paper proceeds as follows. I briefly describe the development of lithium fusion fuel in hydrogen bomb production as well as the market for radioactive metals generally in the early 1950s in Section 2; I observe price reactions of these manufacturers leading up to and after Castle Bravo in Section 3, and make some generalizations about the results in Section 4, with concluding comments in Section 5.

Section snippets

The market for lithium

In late 1948, Soviet scientists proposed using lithium deuteride instead of deuterium and tritium in nuclear bombs. By early 1949, they were told to develop a bomb using lithium. But “at the time, this was just another theory … and would not be revisited for five years” (DeGroot, 2005 pg. 168). Working in parallel in the United States, Edward Teller proposed exploring the use of lithium deuteride in bombs as an alternative fuel to liquid deuterium; being a solid at room temperature, it would

The Operation Castle tests

Operation Castle was part of the effort to develop powerful weapons that were small enough to be delivered by aircraft, a drive requiring innovative bomb designs. The relatively weak bomb at Nagasaki was only 17% efficient as measured by percent of material fissioned, while the Hiroshima bomb was only 1.4% efficient, yielding about 20 and 15 kt each, respectively (see Nuclear Weapon Archive, 2007). Such pure fission atomic weapons used uranium or plutonium fuel. These were followed by the

Generalizations

Market efficiency “gauges the extent to which stock prices quickly and accurately respond to new information” (Maloney and Mulherin, 2003). How secret was Operation Castle in its timing and the nature of the tests, including its role in developing the MK21 and MK17 weapons, and how quickly and by what means was this private information disseminated to the public? The large, sudden increase in price and volatility seen in Lithium Corp. stock beginning in January 1954 indicates new, positive

Conclusion

This event study confirms Armen A. Alchian's report of the event study he conducted at RAND, revealing that he successfully determined the fuel that started being used in hydrogen bombs at that time, contributing to his reputation among the scientists and engineers who developed them. He accomplished this 15 years before what Fama referred to as the original event study, conducted by Fama, Fisher, Jensen, and Roll in 1969 in a study that analyzed stock splits, a development that Fama himself

Acknowledgments

Thanks to Harold Mulherin, William R. Dougan, Robert D. Tollison, Mike Maloney, and the participants of the public economics workshop at Clemson University and the finance department seminar at University of Georgia for helpful comments, and to Daniel K. Benjamin for introducing me to the work of Alchian.

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