Institutional Herding and Future Stock Returns

Abstract:     
When the trading of institutional investors is imbalanced between buys and sells, how are stock prices affected? The extant literature on such herding by institutions concludes that herding promotes price discovery. That is, herding correctly predicts stock returns in the near term. Examining a longer window, we find that herding is negatively related to returns in the second year after the herding. This longer run reversal in returns dominates any shorter run return continuation and suggests that herding pushes prices beyond their intrinsic levels. In addition, consistent with a price pressure interpretation of the longer run reversal, we detect an asymmetry in the relations between buy and sell herding and longer run reversal that mirrors the well-documented buy/sell asymmetry found in the high-frequency studies of institutional trades. Buy herds during up markets push prices too high; sell herds during down markets push prices too low.

Keywords: institutional investors, herding, stock returns

JEL Classifications: G14, G12, G20

Working Paper Series