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The Price Impact of Institutional Herding

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  • Amil Dasgupta
  • Andrea Prat
  • Michela Verardo

Abstract

We develop a simple model of the price impact of institutional herding. The empirical literature indicates 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 trade with security dealers endowed with market power and exhibit an endogenous tendency to imitate past trades. This tendency is exploited by dealers and thus affects prices. In equilibrium, institutional herding positively predicts short-term returns but negatively predicts long-term returns. Our article also generates several new, testable predictions that link institutional herding with the time-series properties of returns and volume. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Suggested Citation

  • Amil Dasgupta & Andrea Prat & Michela Verardo, 2011. "The Price Impact of Institutional Herding," Review of Financial Studies, Society for Financial Studies, vol. 24(3), pages 892-925.
  • Handle: RePEc:oup:rfinst:v:24:y:2011:i:3:p:892-925
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    JEL classification:

    • C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory
    • G0 - Financial Economics - - General

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