Relative Performance and Herding in Financial Markets
We consider a stylised model of a financial market where assets are traded over two periods by three agents: two fund managers and a third large trader that represents the rest of the market. Fund managers are rewarded at the end of the second period by a bonus that is awarded to the manager that obtains the best cumulative performance. We show that, even when information is symmetric, inefficient herding may be observed as an equilibrium outcome. Herding among fund managers occurs when the size of the rest of the market is large, but finite, so that the impact of the herd on equilibrium prices is not negligible abd indeed destabilising for asset prices.
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