Herding and Contrarian Behavior in Financial Markets

48 Pages Posted: 13 Jul 2006 Last revised: 2 Jun 2009

See all articles by Andreas Park

Andreas Park

University of Toronto; University of Toronto - Finance Area

H. Sabourian

University of Cambridge - Faculty of Economics and Politics

Date Written: May 29, 2009

Abstract

Rational herd behavior and informationally efficient security prices have long been considered to be mutually exclusive but for exceptional cases. In this paper we describe the conditions on the underlying information structure that are necessary and sufficient for informational herding and contrarianism. In a standard sequential security trading model, subject to sufficient noise trading, people herd if and only if, loosely, their information is sufficiently dispersed so that they consider extreme outcomes more likely than moderate ones. Likewise, people act as contrarians if and only if their information leads them to concentrate on middle values. Both herding and contrarianism generate more volatile prices, and they lower liquidity. They are also resilient phenomena, although by themselves herding trades are self enforcing whereas contrarian trades are self-defeating. We complete the characterization by providing conditions for the absence of herding and contrarianism.

Keywords: Social learning, herding, contrarians, asset price volatility, market transparency

JEL Classification: D80, D82, G10, G14

Suggested Citation

Park, Andreas and Sabourian, Hamed, Herding and Contrarian Behavior in Financial Markets (May 29, 2009). Available at SSRN: https://ssrn.com/abstract=913728 or http://dx.doi.org/10.2139/ssrn.913728

Andreas Park (Contact Author)

University of Toronto ( email )

105 St George Street
Toronto, Ontario M5S 3G8
Canada

University of Toronto - Finance Area ( email )

Toronto, Ontario M5S 3E6
Canada

Hamed Sabourian

University of Cambridge - Faculty of Economics and Politics ( email )

Austin Robinson Building
Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom
+44 1223 335223 (Phone)
+44 1223 335475 (Fax)

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