The Consequences Of Herding Behavior Of Financial Traders

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Abstract: This report sets out to analyze the causes and the consequences of herding behavior of financial traders, emphasizing the impact on financial markets’ efficiency and stability. Moreover, it contributes to formalize the role of policy makers, how they react to herding behavior and what measures they can take to curtail it. This paper is divided into three section: Section 1 introduces herding behavior; Section 2 analyzes origin and consequences of herding and its repercussion on Efficient Market Hypothesis theory; Section 3 focuses on the role of policy makers and what they can do to curtail herding. Section 1 Herding behavior, which can be addressed of a part of uninformed trading, is defined as instances in which individual…show more content…
Therefore, as presented by West (1988), it is necessary to identify a behavioral model which can highlight the importance and the impact of psychological and irrational behaviors that can explain the latest financial crisis and asset bubbles. The greatest support of what can be defined as Behavioral Finance comes from Shiller (1984), who believes that financial behaviors are influenced by social movements. To explain return patterns that are anomalous from the classical viewpoint of EMH, it is necessary to introduce either market imperfections or failures of human rationality (Hirshleifer et.al, 2003). Herding is one of many psychological factors and biases that influences markets’ stability and can be identified as the cause of many stock markets bubbles and crashes. Moreover herding leads to unhedgeable systemic risk and causes markets’ failure to reflect all relevant information. Section 2 Herd behavior occurs when investors, firms or analysts take the same action and/or base their decisions according to others’ behaviors (Spyrou, 2013) and follow the crowd (i.e. switching from buying to selling and reverse). It is present in a market when individuals imitate better informed investors’ trading strategies rather than acting upon their own beliefs and private information. Moreover, herding must be distinguished from what is known as “spurious herding”. Spurious traders, when facing the same problems and set
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