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What Causes Herding:Information Cascade or Search Cost ?

  • Lin, William
  • Tsai, Shih-Chuan
  • Sun, David

We analyze in this study what could have caused herding in the stock market. Information cascades have often been considered as a major cause. However, we present in this study evidences inconsistent with that hypothesis. Our analysis is in support of an alternative theory based on search cost of investors. Specifically, previous works studied daily data or those with lower frequency based on a herding measure of Lakonishok, Shleifer, and Vishny (1992). We adopt instead the measure of Patterson and Sharma (2006) and argue that the search model of Vayanos and Wang (2007) characterize herding phenomenon better. Our analysis supports their hypothesis employing intraday order book data. We find that stronger order flow herding is driven by lower transactions cost. Herding tend to occur in trading of high-cap, high turnover stocks, which contradicts prediction of the information cascade hypothesis. Information cascade effect, if any, is actually stronger near market close than at open. Therefore our study suggests that herding could be related more to intrinsic search cost structure of investors rather than information related factors.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 20217.

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Date of creation: 03 Feb 2009
Date of revision: 23 Jan 2010
Handle: RePEc:pra:mprapa:20217
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  1. Rama Cont & Jean-Philippe Bouchaud, 1997. "Herd behavior and aggregate fluctuations in financial markets," Science & Finance (CFM) working paper archive 500028, Science & Finance, Capital Fund Management.
  2. Jean-Philippe Bouchaud, 2002. "An introduction to statistical finance," Science & Finance (CFM) working paper archive 313238, Science & Finance, Capital Fund Management.
  3. 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.
  4. Banerjee, Abhijit V, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, MIT Press, vol. 107(3), pages 797-817, August.
  5. Cont, Rama & Bouchaud, Jean-Philipe, 2000. "Herd Behavior And Aggregate Fluctuations In Financial Markets," Macroeconomic Dynamics, Cambridge University Press, vol. 4(02), pages 170-196, June.
  6. 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.
  7. Bouchaud, Jean-Philippe, 2002. "An introduction to statistical finance," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 313(1), pages 238-251.
  8. 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.
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