The Consequences Of Herding Behavior Of Financial Traders

1766 Words Nov 10th, 2014 8 Pages
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 traders gravitate on the same or similar investment, just based on the fact that many others are investing in the same stock. For a long time, stock markets were dominated by the Efficient Market Hypothesis (EMH) model, which believes that no investor could “beat the market” because stock markets efficiency causes share prices to incorporate and reflect all relevant information anytime, so that the price would always adjust toward the equilibrium price. Although this model is supported by many authors such as Eugene Fama (1970), data and empirical studies on the markets’ last financial crises have shown that stock prices show much more volatility than fundamentals or expected returns do (Lux, 1995). Moreover, excess volatility is not consistent…
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