What Causes Herding: Information Cascade or Search Cost?

Posted: 23 Jan 2010 Last revised: 1 May 2010

See all articles by William T. LIn

William T. LIn

Tamkang University - Banking & Finance

Shih-Chuan Tsai

National Taiwan Normal University

David S. Sun

Kainan University

Date Written: April 26, 2010

Abstract

We analyze in this study cause of herding in a stock market. Information cascades have often been considered as a primary choice. However, we propose alternative explanations in this study. Employing intraday order book data, we suggest including an alternative theory based on search cost of investors, in addition to the information cascade argument. Specifically, previous works used data with daily or lower frequency based on a herding measure of Lakonishok, Shleifer, and Vishny (1992). We adopt instead a measure by Patterson and Sharma (2006) and argue that the search model of Vayanos and Wang (2007) characterizes herding phenomenon better, especially at market open. Our analysis is also consistent with the information competition equilibrium of Back, Cao and Willard (2000) and dynamic friction model of Hu (2006). We find that stronger order flow herding takes place when buyers and sellers are 6 times higher as well as when buyer-seller ratio is 50% higher, and is driven by lower transactions cost and shorter order-filling time. Herding tends to occur in trading of high-cap, high turnover stocks, which contradicts prediction of the information cascade hypothesis. Search cost effect is stronger at market open, while information cascade effect is stronger at market close. Therefore our study suggests that herding should be related both to intrinsic search cost structure of investors as well as information related factors.

Keywords: Herding, information cascade, search model, order book

JEL Classification: C14, D82, D83, G12, L11

Suggested Citation

LIn, William T. and Tsai, Shih-Chuan and Sun, David S., What Causes Herding: Information Cascade or Search Cost? (April 26, 2010). Available at SSRN: https://ssrn.com/abstract=1540443 or http://dx.doi.org/10.2139/ssrn.1540443

William T. LIn

Tamkang University - Banking & Finance ( email )

Department of Banking and Finance
Taiwan, 25137
Taiwan

Shih-Chuan Tsai

National Taiwan Normal University ( email )

No. 162, Section 1
Heping East Road
Taipei City, Da’an District 106
Taiwan

David S. Sun (Contact Author)

Kainan University ( email )

No. 1, Kāinán Rd
Taoyuan, Taiwan
Taiwan

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
1,316
PlumX Metrics