Discussion Paper

Herd Behavior in Financial Markets

Abstract: Over the last twenty-five years, there has been a lot of interest in herd behavior in financial markets—that is, a trader’s decision to disregard her private information to follow the behavior of the crowd. A large theoretical literature has identified abstract mechanisms through which herding can arise, even in a world where people are fully rational. Until now, however, the empirical work on herding has been completely disconnected from this theoretical analysis; it simply looked for statistical evidence of trade clustering and, when that evidence was present, interpreted the clustering as herd behavior. However, since decision clustering may be the result of something other than herding—such as the common reaction to public announcements—the existing empirical literature cannot distinguish “spurious” herding from “true” herd behavior.

Keywords: herd behavior; financial markets;

JEL Classification: G1;

Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Liberty Street Economics

Publication Date: 2015-03-09

Number: 20150309