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Risk aversion and herd behavior in financial markets

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Author Info

  • LOVO, Stefano
  • DECAMPS, Jean-Paul

    (GREMAQ-IDEI Universite de Toulouse)

Abstract

We show that differences in investors risk aversion can generate herd behavior in stock markets where assets are traded sequentially. This in turn prevents markets from being efficient in the sense that financial market prices do not converge to the asset's fundamental value. The informational efficiency of the market depends on the distribution of the risky asset across risk averse agents. These results are obtained without introducing multidimensional uncertainty.

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Bibliographic Info

Paper provided by HEC Paris in its series Les Cahiers de Recherche with number 758.

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Length: 36 pages
Date of creation: 14 May 2002
Date of revision:
Handle: RePEc:ebg:heccah:0758

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Postal: HEC Paris, 78351 Jouy-en-Josas cedex, France
Web page: http://www.hec.fr/
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Keywords: herd behavior; stock markets; efficiency;

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References

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  1. Avery, Christopher & Zemsky, Peter, 1998. "Multidimensional Uncertainty and Herd Behavior in Financial Markets," American Economic Review, American Economic Association, American Economic Association, vol. 88(4), pages 724-48, September.
  2. Lawrence R. Glosten & Paul R. Milgrom, 1983. "Bid, Ask and Transaction Prices in a Specialist Market with Heterogeneously Informed Traders," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 570, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  3. Sushil Bikhchandani & David Hirshleifer & Ivo Welch, 2010. "A theory of Fads, Fashion, Custom and cultural change as informational Cascades," Levine's Working Paper Archive 1193, David K. Levine.
  4. Marco Cipriani & Antonio Guarino, 2005. "Herd Behavior in a Laboratory Financial Market," American Economic Review, American Economic Association, American Economic Association, vol. 95(5), pages 1427-1443, December.
  5. Marco Cipriani & Antonio Guarino, . "Herd Behavior and Contagion in Financial Markets," Working Papers, The George Washington University, Institute for International Economic Policy 2010-01, The George Washington University, Institute for International Economic Policy.
  6. Décamps, Jean-Paul & Lovo, Stefano, 2003. "Market Informational Inefficiency, Risk Aversion and Quantity Grid," IDEI Working Papers, Institut d'Économie Industrielle (IDEI), Toulouse 177, Institut d'Économie Industrielle (IDEI), Toulouse.
  7. Banerjee, Abhijit V, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 107(3), pages 797-817, August.
  8. Ho, Thomas & Stoll, Hans R., 1981. "Optimal dealer pricing under transactions and return uncertainty," Journal of Financial Economics, Elsevier, Elsevier, vol. 9(1), pages 47-73, March.
  9. Diamond, Douglas W. & Verrecchia, Robert E., 1987. "Constraints on short-selling and asset price adjustment to private information," Journal of Financial Economics, Elsevier, Elsevier, vol. 18(2), pages 277-311, June.
  10. Sunil Sharma & Sushil Bikhchandani, 2000. "Herd Behavior in Financial Markets: A Review," IMF Working Papers, International Monetary Fund 00/48, International Monetary Fund.
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Citations

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Cited by:
  1. Maria Grazia Romano, 2004. "Learning, Cascades and Transaction Costs," CSEF Working Papers, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy 123, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 01 Feb 2006.
  2. Christophe Chamley, 2005. "Complementarities in Information Acquisition with Short-Term Trades," Boston University - Department of Economics - The Institute for Economic Development Working Papers Series, Boston University - Department of Economics dp-156, Boston University - Department of Economics.
  3. LOVO, Stefano & DECAMPS, Jean-Paul, 2003. "Market informational inefficiency, risk aversion and quantity grid," Les Cahiers de Recherche, HEC Paris 770, HEC Paris.
  4. Christophe Chamley, 2005. "Complementarities in Information Acquisition with Short-Term Trades," Boston University - Department of Economics - Working Papers Series, Boston University - Department of Economics WP2005-027, Boston University - Department of Economics.
  5. J L Ford, David Kelsey and W Pang, 2005. "Ambiguity in Financial Markets: Herding and Contrarian Behaviour," Discussion Papers, Department of Economics, University of Birmingham 05-11, Department of Economics, University of Birmingham.

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