Herding

Abstract: We document strong positive correlation between changes in institutional ownership and returns measured over the same period. The result suggests that either institutional investors positive-feedback trade more than individual investors or institutional herding impacts prices more than herding by individual investors. We find evidence that both factors play a role in explaining the relation. We find no evidence, however, of return mean-reversion in the year following large changes in institutional ownership—stocks institutional investors purchase subsequently outperform those they sell. Moreover, institutional herding is positively correlated with lag returns and appears to be related to stock return momentum. HERDING AND FEEDBACK TRADING HAVE THE POTENTIAL to explain a number of financial phenomena, such as excess volatility, momentum, and reversals in stock prices. Herding is a group of investors trading in the same direction over a period of time; feedback trading involves correlation between herding and lag returns. 1 Although a recent growing body of literature is devoted to investor herding and feedback trading, extant studies take divergent paths. One path depicts individual investors as engaging in herding as a result of irrational, but systematic, responses to fads or sentiment. A second path depicts institutional investors engaging in herding as a result of agency problems, security characteristics, fads, or the manner in which information is impounded in the market.

Abstract: We analyze the trading activity of the mutual fund industry from 1975 through 1994 to determine whether funds “herd” when they trade stocks and to investigate the impact of herding on stock prices. Although we find little herding by mutual funds in the average stock, we find much higher levels in trades of small stocks and in trading by growth-oriented funds. Stocks that herds buy outperform stocks that they sell by 4 percent during the following six months; this return difference is much more pronounced among small stocks. Our results are consistent with mutual fund herding speeding the price-adjustment process. DO INSTITUTIONAL INVESTORS “F LOCK TOGETHER” ~or “herd,” as it is often called! when they trade securities? Do some investors follow the lead of others when they trade? Such questions have interested researchers for some time, and are central to understanding the impact of institutional trading on securities markets and to understanding the way in which information becomes incorporated into market prices. 1