Rational Herding in Financial Economics

Abstract

This paper briefly describes recent papers on economics of rational herding in financial markets. Some models can predict perfect herding, in which rational agents all act alike without any counterveiling force. Such herding typically arises either from direct payoff externalities (negative externalities in bank runs; positive externalities in the generation of trading liquidity or in information acquisition), principal-agent problems (based on managerial desire to protect or signal reputation), or informational learning (cascades). The paper also provides a few pointers to related literature and suggests issues to be addressed in future research.

JEL Classification: G00, D7