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

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