Herd Behaviour

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BB trader
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10 months ago

"Hirshleifer (2001) states that people have a tendency to conform to the judgements and behaviours of others.
People may follow others without any apparent reason. Such behaviour results in a form of herding. If there is
a uniformity of view concerning the direction of a market, the result is likely to be a movement of the market in
that direction.
Herding is an irrational behaviour and low information cost strengthens herding. Banerjee (1992) defines
herding as “everyone doing what everyone else is doing, even when their information suggests doing something different.” Furthermore, Shiller (2000) ventured that the meaning of herd behaviour is that
investors tend to do as other investors did. They imitate the behaviour of others and disregard their own
information. Kultti and Miettinen (2006) proposed that, if the cost of information about predecessors’ actions
is very expensive, then all the agents will act according to their own signals but, if observing is free, everyone
acts in accordance with herding behaviour. Facing financial panic, investors may not have enough time to
collect valuable information from many scattered sources. Investors may herd during financial panic. Prechter
and Parker (2007) suggest that uncertainty about valuation may cause herding.
Walter and Weber (2006) distinguished between intentional and unintentional herding. Intentional herding is
seen as arising from attempts to imitate others, whereas unintentional herding emerges as a result of investors
analysing the same information in the same way. Intentional herding could develop as a consequence of poor
availability of information. Investors might imitate the behaviour of others in the belief that others have traded
on the basis of information. When imitating others in the belief that they are acting on information becomes
widespread, there is an informational cascade.
Another possible cause of intentional herding arises as a consequence of career risk. If a fund manager loses
money whilst others make money, that fund manager’s job may be at risk. If a fund manager loses money
whilst others lose money, there is more job security. So it can be in the fund manager’s interest to do as others
do (this is sometimes referred to as the ‘reputational reason’ for herding). Since fund managers are often
evaluated in relation to benchmarks based on the average performance of fund managers, or based on stock
indices, there could be an incentive to imitate others since that would prevent substantial underperformance
relative to the benchmark"

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