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How Does the Level of Market Liquidity Impact the Prevalence of Herding in European Equity Markets?

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  • Barrow, Daisy

    (University of Warwick)

Abstract

This study investigates the relationship between market liquidity and herding behaviour in European equity markets between 2021 to 2023. While the existing literature has predominantly focused on market volatility and crisis-driven herding, the role of liquidity remains under-explored. Understanding this gap is crucial given the implications of herding for market efficiency. Using exchange-level panel data on midand large-cap firms, this study applies the Cross-Sectional Absolute Deviation (CSAD) methodology of Chang et al. (2000) to detect herding and extends the Carhart (1997) four-factor model to isolate the component of CSAD unexplained by fundamental market characteristics. Liquidity is proxied through both market breadth, via volume and turnover measures, and market depth, via a transformed Amihud (2002) ratio, allowing for a distinction between different liquidity attributes. The results reveal asymmetries, but generally suggest that breadth-based liquidity facilitates herding, supporting the idea that higher market participation amplifies signals to imitate. In contrast, depth-based liquidity appears to discourage herding, suggesting that lower transaction costs enable investors to act more independently. These findings highlight the importance of distinguishing between liquidity characteristics and demonstrate the complex and sensitive role of liquidity conditions in shaping investor behaviour.

Suggested Citation

  • Barrow, Daisy, 2025. "How Does the Level of Market Liquidity Impact the Prevalence of Herding in European Equity Markets?," Warwick-Monash Economics Student Papers 92, Warwick Monash Economics Student Papers.
    • Handle: RePEc:wrk:wrkesp:92
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    File URL: https://warwick.ac.uk/fac/soc/economics/research/wmesp/manage/92_-_barrow.pdf
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    References listed on IDEAS

    as
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    JEL classification:

    • G40 - Financial Economics - - Behavioral Finance - - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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