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Sheep in Wolves' Clothing?

  • Weiner, Robert J.
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    The 1990s have been a decade of upheaval in international financial markets. Much of the responsibility for financial instability has been placed on speculators, particularly hedge funds. Speculative capital has been characterized as "hot money", with capital flows driven by "herding" and "contagion" among players in foreign-exchange, stock, bond, and commodity markets. Policies to deal with financial instability by weakening, or even disabling speculation, have been based largely on anecdote, convenience (speculators have long served as scapegoats for various problems), and ideology, rather than careful analysis. Part of the problem arises from the secrecy with which speculators operate. Since speculative trading cannot easily be observed, it is difficult to assess speculators' contribution, if any, to financial volatility. This paper looks at speculative behavior in one of the largest, and most volatile, international financial markets, petroleum derivatives. It utilizes a large, detailed database on individual trader positions in crude-oil and heating-oil futures markets. The paper is exploratory, focusing on measuring and assessing the tendency of speculators to herd. Two theories behind rational herding behavior are examined - the asymmetric information view (poorly-informed traders make decisions based on observing well-informed traders, rather than market fundamentals) and the monitoring/incentive view (institutiona investors make decisions knowing that their incentives are based on performance relative to a benchmark such as mean returns for a group). These theories generate different predictions regarding the types of speculators most likely to herd. The evidence does not support the view that herding among speculators as a group is widespread in this market. In contrast, evidence in favor of a moderate degree of herding among one group of speculators, commodity-fund managers. The evidence is supportive of the monitoring/incentive theory, but not the asymmetric-information theory.

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    File URL: http://www.green.ecn.ulaval.ca/CahiersGREEN2000/00-01.pdf
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    Paper provided by GREEN in its series Cahiers de recherche with number 0001.

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    Date of creation: 2000
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    Handle: RePEc:lvl:lagrcr:0001
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    1. Woochan Kim & Shang-Jin Wei, 1999. "Foreign Portfolio Investors before and during a Crisis," CID Working Papers 6, Center for International Development at Harvard University.
    2. Russ Wermers, 1999. "Mutual Fund Herding and the Impact on Stock Prices," Journal of Finance, American Finance Association, vol. 54(2), pages 581-622, 04.
    3. Hartzmark, Michael L, 1991. "Luck versus Forecast Ability: Determinants of Trader Performance in Futures Markets," The Journal of Business, University of Chicago Press, vol. 64(1), pages 49-74, January.
    4. Eichengreen, Barry & Tobin, James & Wyplosz, Charles, 1995. "Two Cases for Sand in the Wheels of International Finance," Economic Journal, Royal Economic Society, vol. 105(428), pages 162-72, January.
    5. Takatoshi Ito & Richard K. Lyons & Michael T. Melvin, 1996. "Is There Private Information in the FX Market? The Tokyo Experiment," Working Papers _005, University of California at Berkeley, Haas School of Business.
    6. Fung, William & Hsieh, David A., 1999. "A primer on hedge funds," Journal of Empirical Finance, Elsevier, vol. 6(3), pages 309-331, September.
    7. Manaster, Steven & Mann, Steven C, 1996. "Life in the Pits: Competitive Market Making and Inventory Control," Review of Financial Studies, Society for Financial Studies, vol. 9(3), pages 953-75.
    8. Scott H. Irwin & Satoko Yoshimaru, 1999. "Managed futures, positive feedback trading, and futures price volatility," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 19(7), pages 759-776, October.
    9. Dale, Charles & Zyren, John, 1996. "Noncommercial Trading in the Energy Futures Market," MPRA Paper 47463, University Library of Munich, Germany.
    10. Devenow, Andrea & Welch, Ivo, 1996. "Rational herding in financial economics," European Economic Review, Elsevier, vol. 40(3-5), pages 603-615, April.
    11. 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.
    12. Flood, Robert P & Hodrick, Robert J, 1990. "On Testing for Speculative Bubbles," Journal of Economic Perspectives, American Economic Association, vol. 4(2), pages 85-101, Spring.
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