Herding and Contrarian Behavior in Financial Markets
University of Toronto - Department of Economics
University of Cambridge - Faculty of Economics and Politics
May 29, 2009
Rational herd behavior and informationally efficient security prices have long been considered to be mutually exclusive but for exceptional cases. In this paper we describe the conditions on the underlying information structure that are necessary and sufficient for informational herding and contrarianism. In a standard sequential security trading model, subject to sufficient noise trading, people herd if and only if, loosely, their information is sufficiently dispersed so that they consider extreme outcomes more likely than moderate ones. Likewise, people act as contrarians if and only if their information leads them to concentrate on middle values. Both herding and contrarianism generate more volatile prices, and they lower liquidity. They are also resilient phenomena, although by themselves herding trades are self enforcing whereas contrarian trades are self-defeating. We complete the characterization by providing conditions for the absence of herding and contrarianism.
Number of Pages in PDF File: 48
Keywords: Social learning, herding, contrarians, asset price volatility, market transparency
JEL Classification: D80, D82, G10, G14working papers series
Date posted: July 13, 2006 ; Last revised: June 2, 2009
© 2013 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo5 in 0.422 seconds