Institutional Herding and its Price Impact: Evidence from the Corporate Bond Market

58 Pages Posted: 28 Nov 2016

See all articles by Fang Cai

Fang Cai

Federal Reserve Board

Song Han

Federal Reserve Board - Division of Research and Statistics

Dan Li

Board of Governors of the Federal Reserve System

Yi Li

Federal Reserve Board

Multiple version iconThere are 3 versions of this paper

Date Written: 2016-10

Abstract

Among growing concerns about potential financial stability risks posed by the asset management industry, herding has been considered as an important risk amplification channel. In this paper, we examine the extent to which institutional investors herd in their trading of U.S. corporate bonds and quantify the price impact of such herding behavior. We find that, relative to what is documented for the equity market, the level of institutional herding is much higher in the corporate bond market, particularly among speculative-grade bonds. In addition, mutual funds have become increasingly likely to herd when they sell, a trend not observed among insurance companies and pension funds. We also show that bond investors herd not only within a quarter, but also over adjacent quarters. Such persistence in trading is largely driven by funds imitating the trading behavior of other funds in the previous quarter. Finally, we find that there is an asymmetry in the price impact of herding. While buy herding is associated with a permanent price impact that is consistent with price discovery, sell herding results in transitory yet significant price distortions. The price destabilizing effect of sell herding is particularly strong for high-yield bonds, small bonds, and illiquid bonds and during the recent global financial crisis.

Keywords: Corporate Bond, Herding, Institutional Investors, Liquidity, Return Reversal

JEL Classification: G01, G02, G12, G14, G20

Suggested Citation

Cai, Fang and Han, Song and Li, Dan and Li, Yi, Institutional Herding and its Price Impact: Evidence from the Corporate Bond Market (2016-10). FEDS Working Paper No. 2016-091. Available at SSRN: https://ssrn.com/abstract=2875206 or http://dx.doi.org/10.17016/FEDS.2016.091

Fang Cai (Contact Author)

Federal Reserve Board ( email )

Office of Financial Stability Policy and Research
1801 K St NW
Washington, DC 20551
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202-452-3540 (Phone)
202-263-4850 (Fax)

Song Han

Federal Reserve Board - Division of Research and Statistics ( email )

20th & C. St., N.W.
Washington, DC 20551
United States
202-736-1971 (Phone)
202-452-3891 (Fax)

Dan Li

Board of Governors of the Federal Reserve System

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Yi Li

Federal Reserve Board ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
202-721-4576 (Phone)

HOME PAGE: http://sites.google.com/view/yili/

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