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The Price Impact of Institutional Herding

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  • Dasgupta, Amil
  • Prat, Andrea
  • Verardo, Michela

Abstract

In this paper we develop a simple theoretical model to analyze the impact of institutional herding on asset prices. A growing empirical literature has come to the intriguing conclusion that institutional herding positively predicts short-term returns but negatively predicts long-term returns. We offer a theoretical resolution to this dichotomy. In our model, career-concerned money managers interact with profit-motivated proprietary traders and security dealers endowed with market power. We show that the reputational concerns of fund managers imply an endogenous tendency to imitate past trades, which impacts the prices of the assets they trade. In our main result, we show that institutional herding positively predicts short-term returns but negatively predicts long-term returns. Our theory thus provides a simple and unified framework within which to interpret the empirical literature on the price impact of institutional herding. In addition, our paper generates several new testable predictions linking institutional herding behavior, trading volume, and the time-series properties of stock returns.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7804.

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Date of creation: May 2010
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Handle: RePEc:cpr:ceprdp:7804

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Keywords: career concerns; institutional herding; price impact;

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References

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Citations

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Cited by:
  1. Ľuboš Pástor & Robert F. Stambaugh, 2012. "On the Size of the Active Management Industry," Journal of Political Economy, University of Chicago Press, vol. 120(4), pages 740 - 781.
  2. Dimitri Vayanos & Paul Woolley, 2008. "An Institutional Theory of Momentum and Reversal," NBER Working Papers 14523, National Bureau of Economic Research, Inc.
  3. Moatemri Ouarda & Abdelfatteh El Bouri & Olivero Bernard, 2013. "Herding Behavior under Markets Condition: Empirical Evidence on the European Financial Markets," International Journal of Economics and Financial Issues, Econjournals, vol. 3(1), pages 214-228.
  4. Christopher Boortz & Simon Jurkatis & Stephanie Kremer & Dieter Nautz, 2013. "Institutional Herding in Financial Markets: New Evidence through the Lens of a Simulated Model," Discussion Papers of DIW Berlin 1336, DIW Berlin, German Institute for Economic Research.
  5. Gupta-Mukherjee, Swasti, 2013. "When active fund managers deviate from their peers: Implications for fund performance," Journal of Banking & Finance, Elsevier, vol. 37(4), pages 1286-1305.
  6. Veronica Guerrieri & Peter Kondor, 2010. "Fund managers, career concerns, and asset price volatility," Staff Report 446, Federal Reserve Bank of Minneapolis.
  7. Gabriel Desgranges & Céline Rochon, 2013. "Conformism and public news," Economic Theory, Springer, vol. 52(3), pages 1061-1090, April.
  8. Rudiger, Jesper & Vigier, Adrien, 2013. "Financial Experts, Asset Prices and Reputation," MPRA Paper 51784, University Library of Munich, Germany.
  9. Michael G Papaioannou & Joonkyu Park & Jukka Pihlman & Han van der Hoorn, 2013. "Procyclical Behavior of Institutional Investors During the Recent Financial Crisis: Causes, Impacts, and Challenges," IMF Working Papers 13/193, International Monetary Fund.
  10. Dalia El-Shiaty & Ahmed Abdelmotelib Badawi, 2014. "Herding Behavior in the Stock Market: An Empirical Analysis of the Egyptian Exchange," Working Papers 37, The German University in Cairo, Faculty of Management Technology.

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