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Herding and Contrarian Behaviour in Financial Markets

Author

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  • Park, A.
  • Sabourian, H.

Abstract

Rational herd behavior and informationally efficient security prices have long been considered to be mutually exclusive but for exceptional cases. In this paper we describe the conditions on the underlying information structure that are necessary and sufficient for informational herding and contrarianism. In a standard sequential security trading model, subject to sufficient noise trading, people herd if and only if, loosely, their information is sufficiently dispersed so that they consider extreme outcomes more likely than moderate ones. Likewise, people act as contrarians if and only if their information leads them to concentrate on middle values. Both herding and contrarianism generate more volatile prices, and they lower liquidity. They are also resilient phenomena, although by themselves herding trades are self enforcing whereas contrarian trades are self-defeating. We complete the characterization by providing conditions for the absence of herding and contrarianism.

Suggested Citation

  • Park, A. & Sabourian, H., 2009. "Herding and Contrarian Behaviour in Financial Markets," Cambridge Working Papers in Economics 0939, Faculty of Economics, University of Cambridge.
    • Handle: RePEc:cam:camdae:0939
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    Keywords

    Social learning; herding; contrarians; asset price volatility; market transparency;
    All these keywords.

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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