Market Stress and Herding

Abstract

We propose a new approach to detecting and measuring herding, which is based on the cross-sectional dispersion of the factor sensitivity of assets within a given market. This method enables us to evaluate if there is herding towards particular sectors or styles in the market, including the market index itself, and critically we can also separate such herding from common movements in asset returns induced by movements in fundamentals. We apply the approach to an analysis of herding in the US and South Korean stock markets and find that herding towards the market shows significant movements and persistence independently from and given market conditions and macro factors. We find evidence of herding towards the market portfolio in both bull and bear markets. Contrary to common belief, the Asian Crisis and, in particular, the Russian Crisis reduced herding and are clearly identified as turning points in herding behaviour.

Keywords: Herding, heterogenous beliefs, cross-sectional volatility

JEL Classification: C12, C31, G12, G14