Herd mentality in the stock market
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Herd mentality in the stock market
Herd Mentality in the Stock Market:On the Role of Idiosyncratic Participants with Heterogeneous InformationHa V Dang University of LincolnMi Lin Unive Herd mentality in the stock market ersity of LincolnThis version: 24 September 2016Abstract: Tins paper examines herd behaviour using aggregate market data for stocks, with a focus on the role of idiosyncratic participants with heterogeneous information. We look at herding asymmetry' between up and down markets, taking into considera Herd mentality in the stock market tion the daily price limits and the impact of the recent financial crisis. We also improve upon existing tests for fundamental and non-liuidameiital hHerd mentality in the stock market
erding, as well as proposing a method for investigating herd behaviour of different groups of investors. Empirical evidence based on the Ho Chi Minh SHerd Mentality in the Stock Market:On the Role of Idiosyncratic Participants with Heterogeneous InformationHa V Dang University of LincolnMi Lin Unive Herd mentality in the stock market g following the crisis. We document robust intentional herding even when unintentional (fundamental) herding is factoied out Our empirical results also uncover potential witliin-group herding and between-group interactions among arbitrageurs and noise traders in the market.Key Words: Herd Behaviour. Herd mentality in the stock market Behavioural Finance. Financial Crises. Stock Markets.JEL Classification: G01. G02. GIL1. IntroductionHerding towards the stock market consensus has bHerd mentality in the stock market
een receiving great attention from both academics and policy makers. In the existence of herding, a group of investors tend to trade in the same direcHerd Mentality in the Stock Market:On the Role of Idiosyncratic Participants with Heterogeneous InformationHa V Dang University of LincolnMi Lin Unive Herd mentality in the stock market sirable consequence for risk diversification. As another major consequence of herding, if market participants tend to herd around the market consensus, investors' trading behaviour can cause asset prices to deviate from their fundamentals, resulting in assets being inappropriately priced. Herding th Herd mentality in the stock market us is of considerable concern to market participants, as it could cause investors to transact at inefficient prices (Fama. 1970, Clu istie & Huang. 19Herd mentality in the stock market
95). increase difficulty for investors in pel forming diversification (Chang et al.. 2000: Venezia et al.. 2011). and accelerate financial market volaHerd Mentality in the Stock Market:On the Role of Idiosyncratic Participants with Heterogeneous InformationHa V Dang University of LincolnMi Lin Unive Herd mentality in the stock market strand relies on detailed investor-specific data to detect herding by institutional investors in the form of correlation in trading patterns among a particular group of investors, usually fund managers (see. among others. Lakomshok et al., 1992: Grmblatt et al.. 1995: Wenners. 1999: and Frey et al.. Herd mentality in the stock market 2014). The second strand makes use of aggregate market data and aims at uncovering co-movements towards the market consensus due to individual investHerd mentality in the stock market
ors' behaviour (see. among others. Christie & Huang. 1995: Chang et al.. 2000: Galanotis et al., 2015). This paper falls within the second strand, tesHerd Mentality in the Stock Market:On the Role of Idiosyncratic Participants with Heterogeneous InformationHa V Dang University of LincolnMi Lin Unive Herd mentality in the stock market ence documented ill the literature indicates that herd behaviour is more likely to occur in emerging markets, where there might not be many experienced market participants and the governing lilies regaiding the release and the flow of information are limited, leading to diverse responses and interac Herd mentality in the stock market tions among idiosyncratic investors when they are exposed to heterogeneous information. For instance, investors might act differently in the process oHerd mentality in the stock market
f collecting and analysing information. Less sophisticated investors may find It costly to collect and analyse information on their own. and thereforeHerd Mentality in the Stock Market:On the Role of Idiosyncratic Participants with Heterogeneous InformationHa V Dang University of LincolnMi Lin Unive Herd mentality in the stock market nformation asymmetry also plays a major role in creating herds. Bikhchairdani and Sharma (2001) argue that, under the situation of information asymmetry, some investors nriglrt supress then own sets of private information and turn to follow others' behaviour due to intrinsic prefer CTree for conform Herd mentality in the stock market ity. When investors do not make then investment decisions simultaneously, such information cascades could easily turn into so-called intentional herdiHerd mentality in the stock market
ng. Moreover, when investors are faced with inadequate supply of firm-specific information, which is likely to happen in emerging markets, they might Herd Mentality in the Stock Market:On the Role of Idiosyncratic Participants with Heterogeneous InformationHa V Dang University of LincolnMi Lin Unive Herd mentality in the stock market tion sets (such as fimdamental information regarding the macro economy and aggregate financial market). Such phenomenon, discussed in Bikhclrandani & Shanna (2001). is referred to as spurious herding and has subsequently been investigated in Klein (2013). Bold et al. (2011). and Galariotis et al. (2 Herd mentality in the stock market 015). Consequently, heterogeneity among market participants and information could be a key factor in detenmning and hence to understand herd behaviourHerd mentality in the stock market
111 emerging markets. Empirical research on herding behavrour in emerging markets with a focus on the role of idiosyncratic participants with heterogHerd Mentality in the Stock Market:On the Role of Idiosyncratic Participants with Heterogeneous InformationHa V Dang University of LincolnMi Lin Unive Herd mentality in the stock market revealing the existence and the causing mechanism of herding empirically. One of the challenges is to purge out the impact of spurious herding so as to isolate and identify true (intentional) herding, since iiifoimalioii on lire macro economy and the aggregate market is commonly known to the public Herd mentality in the stock market , convergence in investors' behaviour based on such information most likely docs not necessarily involve investors reversing their decisions, and thusHerd mentality in the stock market
strictly speaking, is not herding (Bikhchandani & Sharma. 2001). It is therefore important to factor out such fundamental-driven (spurious) herding bHerd Mentality in the Stock Market:On the Role of Idiosyncratic Participants with Heterogeneous InformationHa V Dang University of LincolnMi Lin Unive Herd mentality in the stock market ntensity of herding. To address this issue, we follow the approach adopted in Galariotis er al. (2015) to separate and quantify spurious and intentional herding. More specifically', we decompose return dispersion (Cross Sectional Absolute Deviation. CSAD) into two parts by regressing It on conventio Herd mentality in the stock market nal return factors (i.e.. size, book-to-market. and momentum) proposedin Fama & French (1995, 1996) and Carhart (1997).1 Given that these return factoHerd mentality in the stock market
rs capture significant information on the dynamics of macro economy and aggiegate financial market, the fitted value of this regression captures dispeHerd Mentality in the Stock Market:On the Role of Idiosyncratic Participants with Heterogeneous InformationHa V Dang University of LincolnMi Lin Unive Herd mentality in the stock market ls from this regression captures dispersions due to investors responding to nonfundamental information. * Using this approach. Galariotis et al (2015) document non-fiuidamental herding in UK and US and intentional herding in US. Ill this paper, we explore the possibility of implementing this method Herd mentality in the stock market using data from an emerging country. Further discussions on this approach are presented in Section 2.Another challenge is to build a closer hnk betweeHerd mentality in the stock market
n theoretical arguments and empirical studies 111 order to identify the cause of herd mentality. Theoretical wisdom regarding causes of herding 111 thHerd Mentality in the Stock Market:On the Role of Idiosyncratic Participants with Heterogeneous InformationHa V Dang University of LincolnMi Lin Unive Herd mentality in the stock market i et al.. 1998), reputation-based herding (Scharfstein & Stein. 1990; Zwiebel. 1995; Prendergast & Stole. 1996; and Graham. 1999; Rajan. 2006), and herding due to compensation structures (Trueman. 1994; Maug & Naik. 1996; and Admati & Pfleiderer. 1997). Whilst theoretical models on this topic are we Herd mentality in the stock market ll developed, most empirical studies in the cun ent literature nevertheless are based on purely statistical approaches usually not derived from theoreHerd mentality in the stock market
tical models. This is due to the fact that detailed and reliable data that could be used to directly test these theories are scarce. Though we too do Herd Mentality in the Stock Market:On the Role of Idiosyncratic Participants with Heterogeneous InformationHa V Dang University of LincolnMi Lin Unive Herd mentality in the stock market l dominant causes of herding by incorporating idiosyncrasy among stock market participants in the analysis to further explore herds due to responses and interactions among idiosyncratic investors when they are exposed to1 Tins is ill line with approaches proposed by Klein (2013) and Bohl et al. (201 Herd mentality in the stock market 4). wlio also utilised Faina-French and macroeconomics factors in then regressions to control for fundamental (spurious) herding. Ill our paper, we atHerd mentality in the stock market
tempt to separate and quantify- these two types of herding.- Licw & Vassalou (2000) find that the two factors HML and SMB embody significant informatiGọi ngay
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