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Herding in financial markets: Bridging the gap between theory and evidence

  • Christopher Boortz
  • Simon Jurkatis
  • Stephanie Kremer
  • Dieter Nautz

Due to data limitations and the absence of testable, model-based predictions, theory and evidence on herd behavior are only loosely connected. This paper attempts to close this gap in the herding literature. From a theoretical perspective, we use numerical simulations of a herd model to derive new, theory-based predictions for aggregate herding intensity. From an empirical perspective, we employ high-frequency, investor-specific trading data to test the theory-implied impact of information risk and market stress on herding. Confirming model predictions, our results show that herding intensity increases with information risk. In contrast, herding measures estimated for the financial crisis period cannot be explained by the herd model. This suggests that the correlation of trades observed during the crisis is mainly due to the common reaction of investors to new public information and should not be misinterpreted as herd behavior.

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File URL: http://sfb649.wiwi.hu-berlin.de/papers/pdf/SFB649DP2013-036.pdf
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Paper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2013-036.

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Length: 34 pages
Date of creation: Jul 2013
Date of revision:
Handle: RePEc:hum:wpaper:sfb649dp2013-036
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  1. Chiang, Thomas C. & Zheng, Dazhi, 2010. "An empirical analysis of herd behavior in global stock markets," Journal of Banking & Finance, Elsevier, vol. 34(8), pages 1911-1921, August.
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  3. Park, Andreas & Sgroi, Daniel, 2012. "Herding, contrarianism and delay in financial market trading," European Economic Review, Elsevier, vol. 56(6), pages 1020-1037.
  4. Kremer, Stephanie & Nautz, Dieter, 2013. "Causes and consequences of short-term institutional herding," Journal of Banking & Finance, Elsevier, vol. 37(5), pages 1676-1686.
  5. 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.
  6. Park, A. & Sabourian, H., 2009. "Herding and Contrarian Behaviour in Financial Markets," Cambridge Working Papers in Economics 0939, Faculty of Economics, University of Cambridge.
  7. Cipriani Marco & Guarino Antonio, 2008. "Herd Behavior and Contagion in Financial Markets," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 8(1), pages 1-56, October.
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  12. Brad M. Barber & Terrance Odean & Ning Zhu, 2009. "Do Retail Trades Move Markets?," Review of Financial Studies, Society for Financial Studies, vol. 22(1), pages 151-186, January.
  13. Banerjee, Abhijit V, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, MIT Press, vol. 107(3), pages 797-817, August.
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  16. Avery, Christopher & Zemsky, Peter, 1998. "Multidimensional Uncertainty and Herd Behavior in Financial Markets," American Economic Review, American Economic Association, vol. 88(4), pages 724-48, September.
  17. Choi, Nicole & Sias, Richard W., 2009. "Institutional industry herding," Journal of Financial Economics, Elsevier, vol. 94(3), pages 469-491, December.
  18. Patterson, Douglas M. & Sharma, Vivek, 2010. "The Incidence Of Informational Cascades And The Behavior Of Trade Interarrival Times During The Stock Market Bubble," Macroeconomic Dynamics, Cambridge University Press, vol. 14(S1), pages 111-136, May.
  19. Andreas Walter & Friedrich Moritz Weber, 2006. "Herding in the German Mutual Fund Industry," European Financial Management, European Financial Management Association, vol. 12(3), pages 375-406.
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  25. Chang, Eric C. & Cheng, Joseph W. & Khorana, Ajay, 2000. "An examination of herd behavior in equity markets: An international perspective," Journal of Banking & Finance, Elsevier, vol. 24(10), pages 1651-1679, October.
  26. Zhou, Rhea Tingyu & Lai, Rose Neng, 2009. "Herding and information based trading," Journal of Empirical Finance, Elsevier, vol. 16(3), pages 388-393, June.
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