Rational herding

In economics and finance, rational herding is a situation in which market participants react to information about the behavior of other market agents or participants rather than the behavior of the market, and the fundamental transactions.[1][2]

An account cited that rational herding is an unintended consequence of the string of Federal Reserve interventions that mandated greater transparency of others’ trade activities starting in 2007.[3] Due to crisis environment and uncertainty in the market fundamentals, investors started to use the Federal Reserve’s information found in its policy pronouncements.[3]

Rational herding in financial markets can take place because some investors believe others to be better informed than themselves, and follow them, disregarding their own information or market fundamentals.[4] This is based on the idea that if information is costly for an uninformed actor, his ignorance is rational and that, if he cannot afford the information, there is a potential benefit of following another player who can pay for such information.[5]

Reliance on rational herding can be a source of instability in financial markets.[1] There are also scholars who note that rational herding is still based on anecdotal observations and that there is lack of empirical evidence due to the way the so-called “herding literature” focuses on the price or investment patterns, information that is readily available.[6]

References

  1. ^ Jump up to:ab International economic policy review, Volume 2 by International Monetary Fund 2001 ISBN 1-58906-030-X page 100 [1]
  2. ^Andrea Devenow and Ivo Welch Rational herding in financial economics in European Economic Review Volume 40, Issues 3-5, April 1996, Pages 603-615 [2]
  3. ^ Jump up to:ab Fung, Hung-Gay; Tse, Yiuman (2013). International Financial Markets. Bingley, UK: Emerald Group Publishing. p. 159. ISBN 9781781903117.
  4. ^Handbook of Behavioral Finance edited by Brian Bruce 2010 ISBN 1-84844-651-9 page 103 [3]
  5. ^Baker, H. Kent; Nofsinger, John R. (2010). Behavioral Finance: Investors, Corporations, and Markets. Hoboken, NJ: John Wiley & Sons. p. 459. ISBN 9780470499115.
  6. ^Menkhoff, Lukas; Tolksdorf, Norbert (2001). Financial Market Drift: Decoupling of the Financial Sector from the Real Economy?. Berlin: Springer-Verlag. p. 165. ISBN 3540411658.

Ofer Abarbanel – Executive Profile

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Ofer Abarbanel online library