Academic journal article International Review of Management and Business Research

Herding Behavior and Trading Volume: Evidence from the American Indexes

Academic journal article International Review of Management and Business Research

Herding Behavior and Trading Volume: Evidence from the American Indexes

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Introduction

Modeling the decision making process of various participants in the market has become a challenge for financial researchers. While conventional efficient theory assumes that markets are informationally efficient and agents are fully rational, there is an increasing empirical insight that agents are not rational and commit systematic errors, which are manifested in the form of inefficient prices. Grullon et al., (2005) and several authors assert that only the behavioral finance (based on psychological biases and emotions) could bring an assuasive apprehension of the complex puzzle of human?s decision-making. More particularly, in the recent years, several authors provided direct empirical evidences that investors? stock trading behavior (e.g., stock performance, stock volume, and stock frequency) is affected by their personality traits and psychological biases (e.g., overconfidence, loss aversion, herd behavior, ...etc.). However, very limited scholars surveyed the different and subtitle ways in which each of these psychological biases influence the investor trading behavior. One of the most central cognitive biases of behavioral theory is herd behavior. Herding occurs when an investor denies his own information to fell prey into a collective uniformed behavior or group, even if the behavior of this group is not supported by relevant information.

Although the extensive surveys on herding behavior in global financial markets, the deterministic feature that underlies this phenomena remains enigmatic. For instance, herding relation with stock performance is confusing. While one line of research describes herding behavior as a rational behavior in which the investor intentionally imitate other investors? investment decision in order to protect his own interest (Scharfstein & Stein, 1990; Banerjee, 1992; Devenow & Welch, 1996), a large stream of scholars consider herding as irrational behavior. Indeed under uncertainly and fear to commit wrong decision, individuals emerge into a collective trading (buying or selling) willful blindness ignoring their information and market signals. Herding is a key feature of behavioral finance in explaining market bubbles and crashes because it is considered as a driving force of bubble and price?s deviation from its fundamental value. In presence of social connectivity (through conversation, sport activity, commentators, and media), erroneous thought and beliefs can be conveyed from one individual to another generating an increasing bubble and leading to market destabilization (Dawkins, 1976). Thus, detecting herding behavior provides evidence against the theory of rationality (Lao & Singh, 2011), and provides a direct implication of market information efficiency (Yao, Ma, & He, 2014). Bikhchandani, Hirshleifer, & Welch (1992) advanced a herding model based on ? information cascade showing that agents abandon their proper private information to act identically to a group of investors. Such conformity often leads under-diversified portfolio and generates a shift in stock variance and a subsequent high volatility.

Previous surveys of market wide herding on the American market are confused. Actually, Christie & Huang (1995) examined herding behavior in the U.S. market and conclude the absence of this bias. However, Nofsinger & Sias (1999) provides evidence that supports herding among investors in the U.S. markets. Lately, Chiang & Zheng (2010) provided empirical evidence on the absence of herding in the U.S. market, while in the same time Hwang & Salmon (2004) and Zhou & Lai (2009) have detected herding behavior in the NYSE, AMEX and NASDAQ index. These contradicting results on the existence of herding in the U.S. market are an incentive to reexamine this bias and survey its magnitude on American stock prices. Moreover, less is known on how this bias influences investors? trading behavior and whether herding increases trading frequency and stock performance or not. …

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