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Herd Behavior in Financial Markets: An Experiment with Financial Market Professionals

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Author Info
Antonio Guarino (University College London)
Marco Cipriani (George Washington University)

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Abstract

We study herd behavior in a laboratory ?nancial market with ?- nancial market professionals. An important novelty of the experi- mental design is the use of a strategy-like method. This allows us to detect herd behavior directly by observing subjects?decisions for all realizations of their private signal. In the paper, we compare two treatments - one in which the price adjusts to the order ?ow in such a way that herding should never occur, and one in which the presence of event uncertainty makes herding possible. In the ?rst treatment, traders herd seldom, in accordance with both the theory and previous experimental evidence on student subjects. A proportion of traders, however, engage in contrarianism, something not accounted for by the theory. In the second treatment, on the one hand, the proportion of herding decisions increases, but not as much as the theory would sug- gest; on the other hand, contrarianism disappears altogether. In both treatments, in contrast with what theory predicts, subjects sometimes prefer to abstain from trading, which a¤ects the process of price discovery negatively.

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Paper provided by ESRC World Economy and Finance Research Programme, Birkbeck, University of London in its series WEF Working Papers with number 0047.

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Date of creation: Feb 2008
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Handle: RePEc:wef:wpaper:0047

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  4. David Hirshleifer & Siew Hong Teoh, 2003. "Herd Behaviour and Cascading in Capital Markets: a Review and Synthesis," European Financial Management, Blackwell Publishing Ltd, vol. 9(1), pages 25-66. [Downloadable!] (restricted)
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  5. Huck, Steffen & Oechssler, Jorg, 2000. "Informational cascades in the laboratory: Do they occur for the right reasons?," Journal of Economic Psychology, Elsevier, vol. 21(6), pages 661-671, December. [Downloadable!] (restricted)
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  6. Richard W. Sias, 2004. "Institutional Herding," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 17(1), pages 165-206. [Downloadable!] (restricted)
  7. Bikhchandani, Sushil & Hirshleifer, David & Welch, Ivo, 1992. "A Theory of Fads, Fashion, Custom, and Cultural Change in Informational Cascades," Journal of Political Economy, University of Chicago Press, vol. 100(5), pages 992-1026, October. [Downloadable!] (restricted)
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  11. Marco Cipriani & Antonio Guarino, 2005. "Noise Trading in a Laboratory Financial Market: A Maximum Likelihood Approach," Journal of the European Economic Association, MIT Press, vol. 3(2-3), pages 315-321, 04/05. [Downloadable!] (restricted)
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  17. Lakonishok, Josef & Shleifer, Andrei & Vishny, Robert W., 1992. "The impact of institutional trading on stock prices," Journal of Financial Economics, Elsevier, vol. 32(1), pages 23-43, August. [Downloadable!] (restricted)
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  19. Lones Smith & Peter Sorensen, 2000. "Pathological Outcomes of Observational Learning," Econometrica, Econometric Society, vol. 68(2), pages 371-398, March.
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  20. Cipriani, Marco & Guarino, Antonio, 2008. "Transaction costs and informational cascades in financial markets," Journal of Economic Behavior & Organization, Elsevier, vol. 68(3-4), pages 581-592, December. [Downloadable!] (restricted)
  21. Jordi Brandts & Gary Charness, 2000. "Hot vs. Cold: Sequential Responses and Preference Stability in Experimental Games," Experimental Economics, Springer, vol. 2(3), pages 227-238, March. [Downloadable!] (restricted)
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  22. Jeannette Brosig & Joachim Weimann & Chun-Lei Yang, 2003. "The Hot Versus Cold Effect in a Simple Bargaining Experiment," Experimental Economics, Springer, vol. 6(1), pages 75-90, June. [Downloadable!] (restricted)
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  26. repec:bep:thecon:v:8:y:2008:i:1:p:1390-1390 is not listed on IDEAS
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  28. Dasgupta, Amil & Prat, Andrea, 2008. "Information aggregation in financial markets with career concerns," Journal of Economic Theory, Elsevier, vol. 143(1), pages 83-113, November. [Downloadable!] (restricted)
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  31. Urs Fischbacher, 2007. "z-Tree: Zurich toolbox for ready-made economic experiments," Experimental Economics, Springer, vol. 10(2), pages 171-178, June. [Downloadable!] (restricted)
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