Institutional Herding, Credit Rating and Overreaction in Stock Price

Abstract

This paper examines institutional investors’herding behavior around credit rating changes. We find that institutions herd into stocks with recent rating upgrades and herd out of stocks with recent downgrades, with a stronger effect for rating downgrades and large rating changes. These results remain after controlling for earnings surprises and analysts’recommendation revisions and are more pervasive for firms with lower credit quality and riskier stocks. Results from cross-sectional tests by firm- and institution-type suggest that the overreaction associated with institutional herding is mainly due to rating downgrades-induced herding and is more consistent with reputational herding.

Keywords: Institutional Herding, Credit Rating, Overreaction