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, represented by Wermers (1999) and Sias (2004), concludes that herding promotes price discovery and helps adjust prices to their intrinsic levels. That is, they find herding to correctly predict stock returns in the coming months. In contrast, two to three years after the herding, we find that stocks with buy herds realize negative abnormal returns. This longer run reversal in returns is robust across subperiods and performance metrics and impedes the interpretation of herding as solely promoting price discovery. In addition, we find that non-13F investors, roughly labeled individual investors, suffer these longer run reversals in returns. The performances of the herding and nonherding institutions are less clear. On the sell side, however, herding does not explain future abnormal returns.

Keywords: institutional investors, herding, stock returns, destabilization, stabilization

JEL Classifications: G14, G12, G20

Working Paper Series