What Causes Herding:Information Cascade or Search Cost ?

William Lin, Shih-Chuan Tsai and David Sun

MPRA Paper from University Library of Munich, Germany

Abstract: We analyze in this study what could have caused herding in the stock market. Information cascades have often been considered as a major cause. However, we present in this study evidences inconsistent with that hypothesis. Our analysis is in support of an alternative theory based on search cost of investors. Specifically, previous works studied daily data or those with lower frequency based on a herding measure of Lakonishok, Shleifer, and Vishny (1992). We adopt instead the measure of Patterson and Sharma (2006) and argue that the search model of Vayanos and Wang (2007) characterize herding phenomenon better. Our analysis supports their hypothesis employing intraday order book data. We find that stronger order flow herding is driven by lower transactions cost. Herding tend to occur in trading of high-cap, high turnover stocks, which contradicts prediction of the information cascade hypothesis. Information cascade effect, if any, is actually stronger near market close than at open. Therefore our study suggests that herding could be related more to intrinsic search cost structure of investors rather than information related factors.

Keywords: Herding; information cascade; search model; order book (search for similar items in EconPapers)
JEL-codes: C14 D82 D83 G12 L11 (search for similar items in EconPapers)
Date: 2009-02-03, Revised 2010-01-23
New Economics Papers: this item is included in nep-mst
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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