A Dynamic Measure of Intentional Herd Behavior in Financial Markets

Park, Beum-Jo and Kim, Myung-Joong (2017): A Dynamic Measure of Intentional Herd Behavior in Financial Markets.

Abstract

This paper suggests a dynamic measure of intentional herding, causing the excess volatility or even systemic risk in financial markets, which is based on a new concept of cumulative returns in the same direction as well as the collective behavior of all investors towards the market consensus. Differing from existing measures, the measure allows us to directly detect time-varying and market-wide intentional herding using the model of Dynamic Conditional Correlation (DCC) (Engle, 2002) between the financial market and its components that is partially free of spurious herding due to the inclusion of the variables of the number of economic news announcements as a proxy of market information. Strong evidence in favor of the dynamic measure over the other measures is based on empirical application in the U.S. markets (DJIA and S&P100), supporting the tendency to exhibit time-varying intentional herding. Much more important is a finding that the impact of intentional herding on market volatility tends to be stronger during the periods of turbulent markets like the degradation of U.S. sovereign credit rating by S&P, and be more significant in S&P 100 than DJIA.

• Item Type: MPRA Paper
• Language: English
• Keywords: Intentional herd behavior, Dynamic conditional correlation, News announcements, Dynamic measure, Herding tests, Volatility, Quantile regression
• Subjects: C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C10 - General; G - Financial Economics > G0 - General; G - Financial Economics > G0 - General > G02 - Behavioral Finance: Underlying Principles

References

Atkins, Al. B., and S. Basu (1991), "The impact of public announcements made after the stock market closes," Unpublished manuscript, University of Arizona and University of Denver.

Avramov, D., T. Chordia and A. Goyal (2006), “Liquidity and autocorrelations in individual stock returns,” Journal of Finance, 61(5), 1242-1277.

Avery, C. and P. Zemsky (1998), "Multidimensional uncertainty and herd behavior in financial markets," The American Economic Review 88(4), 724-748.

Banerjee, A. V. (1992), "A simple model of herd behavior," Quarterly Journal of Economics 107(3), 797-817.

Barclay, M. J., and J. B. Warner (1993), "Stealth trading and volatility: Which trades move prices?" Journal of Financial Economics 34(3), 281-305.

Bekaert, G., and C. R. Harvey (2000), "Foreign speculators and emerging equity markets," The Journal of Finance 55(2), 565-613.

Berry, T., and B. Howe (2000), "Risk factors for disordered eating in female university athletes," Journal of sport behavior 23(3), 207-218.

Bikhchandani, S., D. Hirshleifer, and I. Welch (1992), "A theory of fads, fashion, custom, and cultural change in information cascades," Journal of Political Economy 100(5), 992-1026.

Bikhchandani, S. and S. Sharma (2000), "Herd behavior in financial markets: A review," IMF Working Paper WP/00/48.

Blasco, N. and S. Ferreruela (2008), "Testing intentional herding in familiar stocks: an experiment in an international context," Journal of Behavioral Finance 9(2), 72-84.

Bohl, M., Branger, N. and M. Trede (2017), “The case for herding is stronger than you think,” Journal of Banking and Finance 85, 30-40.

Boyer, B., T. Kumagai, and K. Yuan (2006), "How do crises spread? Evidence from accessible and inaccessible stock indices," The Journal of Finance 61(2), 957-1003.

Brock, W. and C. Hommes (1998), “Heterogeneous beliefs and routes to chaos in a simple asset pricing model,” Journal of Economic Dynamics and Control 22, 1235-1274.

Campbell, J. Y. and A. S. Kyle (1993), "Smart money, noise trading and stock price behavior," Review of Economic Studies 60(1), 1-34.

Chang, E. C., J. W. Cheng and A. Khorana (2000), "An examination of herd behavior in equity markets: An international perspective," Journal of Banking and Finance 24, 1651-1679.

Chen, T. (2013), "Do investors herd in global stock markets?" Journal of Behavioral Finance 14(3), 230-239.

Chiang, T. C., B. N. Jeon, and H. Li (2007), "Dynamic correlation analysis of financial contagion: Evidence from Asian markets," Journal of International Money and finance 26(7), 1206-1228.

Christie, W. G. and R. D. Huang (1995), "Following the pied piper: Do individual returns herd around the market?" Financial Analysts Journal (July-August), 31-37.

Copeland, T. E. (1976), "A model of asset trading under the assumption of sequential information arrival," Journal of Finance 31, 1149-1168.

Corsetti, G., M. Pericoli, and M. Sbracia (2005), "‘Some contagion, some interdependence’: More pitfalls in tests of financial contagion," Journal of International Money and Finance 24(8), 1177-1199.

De Long, J. B., A. Shleifer, L. H. Summers, and R. J. Waldmann (1990), "Noise trader risk in financial markets," Journal of Political Economy 98(4), 703-738.

Demirer, R., and A. Kutan (2006), "Does herding behavior exist in Chinese stock markets?" Journal of international Financial markets, institutions and money 16(2), 123-142.

Devenow, A. and I. Welch (1996), “Rational herding and financial economics”, European Economic Review 40, 603-615.

Dhaene, J., D. Linders, W. Schoutens, and D. Vyncke (2012), "The herd behavior index: A new measure for the implied degree of co-movement in stock markets," Insurance: Mathematics and Economics 50(30), 357-370.

Engle, R. F. (2002), "Dynamic conditional correlation: A simple class of multivariate Garch models," Journal of Business and Economic Statistics 20, 339-350.

Hwang, S. and M. Salmon (2004), "Market stress and herding," Journal of Empirical Finance 11(4), 585-616.

Jeon, J. Q., and C. M. Moffett (2010), "Herding by foreign investors and emerging market equity returns: Evidence from Korea," International Review of Economics & Finance 19(4), 698-710.

Karolyi, A. and R. Stulz (1996), “Why do markets move together? An investigation of U.S.-Japan stock return comovements,” Journal of Finance 51(3), 951-986.

King, M., Sentana, E., and S. Wadhwani (1994), “Volatility and links between national stock markets,” Econometrica 62 (4), 901-933.

Kodres, L. E. and M. Pritsker (2002), "A rational expectations model of financial contagion," The Journal of Finance 57(2), 769-799.

Koenker, R. (2005), Quantile regression, Cambridge University Press.

Koutmos, G., and R. Saidi (2001), "Positive feedback trading in emerging capital markets," Applied Financial Economics 11(3), 291-297.

Lakonishok, J., A. Shelifer and R. W. Vishny (1992), "The impact of institutional trading on stock prices," Journal of Financial Economics 32, 23-43.

Mitchell, M. L. and J. H. Mulherin (1994), "The impact of public information on the stock market," The Journal of Finance 49(3), 923-950.

Nofsinger, J. R. and R. W. Sias (1999), "Herding and feedback trading by institutional and individual investors," The Journal of Finance 6, 2263-2295.

Park, B.-J. (2011), “Asymmetric herding as a source of asymmetric return volatility,” Journal of Banking and Finance 35, 12657-2665.

Park, B.-J. (2014), “Time-varying, heterogeneous risk aversion and dynamics of asset prices among boundedly rational agents,” Journal of Banking and Finance 43, 150-159.

Patterson, D. and V. Sharma (2005), "Intraday herding and market efficiency," Working Paper, University of Michigan-Dearborn.

Penman, S. (1987), "The distribution of earnings news over time and seasonalities in aggregate stock returns," Journal of financial economics 18(2), 199-228.

Sentana, E. and S. Wadhwani (1992), "Feedback traders and stock return autocorrelations: Evidence from a century of daily data," The Economic Journal 102, 415-425.

Sias, R. W. (2004), "Institutional herding," Review of Financial Studies, 17(1), 165-206.

Sias, R. W., and L. T. Starks (1997), "Return autocorrelation and institutional investors," Journal of Financial economics 46(1), 103-131.

Tan, L., T. C. Chiang, J. R. Mason, and E. Nelling (2008), "Herding behavior in Chinese stock markets: An examination of A and B shares," Pacific-Basin Finance Journal 16(1), 61-77.

Thompson, R., C. Olson, and R. Dietrich (1987), “Attributes of news about firms: An analysis of firm-specific news reported in the wall street journal index,” Journal of Accounting Research 25(2), 245-274.

Walter, A. and F. Weber (2006), “Herding in the German mutual fund industry,” European Financial Management 3(12), 375-406.