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The impact of signal dependence and own ability awareness on herding behaviour: a tale of two managers

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  • Xeni Dassiou

    (Department of Economics, City University, Northampton Square, London EC1V 0HB, UK)

Abstract

This model examines the case of managers whose signals, when informative, are perfectly correlated as in the Scharfstein and Stein model [1990. The American Economic Review 80(3): 465-479]. This has a herd increasing impact as it introduces a positive reputation externality. On the other hand, it is also assumed that managers have perfect knowledge of their own ability, an assumption with herd reducing implications. Combining these two offsetting, in terms of herding, assumptions, it is found that a smart manager who plays first will sometimes, but not always, truthfully announce his|her private information. On the other hand, a smart manager who plays second will always report his|her true signal, while a dumb manager who plays second may herd, either on the first manager's action and|or on the prior. It is also found that the more likely a dumb manager who plays second is to herd on the first manager's action, the less likely is a smart manager who plays first to herd on the prior. Copyright © 1999 John Wiley & Sons, Ltd.

Suggested Citation

  • Xeni Dassiou, 1999. "The impact of signal dependence and own ability awareness on herding behaviour: a tale of two managers," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 20(7), pages 379-395.
    • Handle: RePEc:wly:mgtdec:v:20:y:1999:i:7:p:379-395
    DOI: 10.1002/1099-1468(199911)20:7<379::AID-MDE955>3.0.CO;2-#
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    References listed on IDEAS

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    1. Jay Pil Choi, 1997. "Herd Behavior, the 'Penguin Effect,' and the Suppression of Informational Diffusion: An Analysis of Informational Externalities and Payoff Interdependency," RAND Journal of Economics, The RAND Corporation, vol. 28(3), pages 407-425, Autumn.
    2. 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.
    3. Dow, James & Gorton, Gary, 1997. "Noise Trading, Delegated Portfolio Management, and Economic Welfare," Journal of Political Economy, University of Chicago Press, vol. 105(5), pages 1024-1050, October.
    4. Trueman, Brett, 1994. "Analyst Forecasts and Herding Behavior," The Review of Financial Studies, Society for Financial Studies, vol. 7(1), pages 97-124.
    5. Peter Sorensen & Marco Ottaviani, 2000. "Herd Behavior and Investment: Comment," American Economic Review, American Economic Association, vol. 90(3), pages 695-704, June.
    6. Avery, Christopher N. & Chevalier, Judith A., 1999. "Herding over the career," Economics Letters, Elsevier, vol. 63(3), pages 327-333, June.
    7. Prendergast, Canice & Stole, Lars, 1996. "Impetuous Youngsters and Jaded Old-Timers: Acquiring a Reputation for Learning," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1105-1134, December.
    8. John R. Graham, 1999. "Herding among Investment Newsletters: Theory and Evidence," Journal of Finance, American Finance Association, vol. 54(1), pages 237-268, February.
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