Working Paper: CEPR ID: DP7804
Authors: Amil Dasgupta; Andrea Prat; Michela Verardo
Abstract: In this paper we develop a simple theoretical model to analyze the impact of institutional herding on asset prices. A growing empirical literature has come to the intriguing conclusion that institutional herding positively predicts short-term returns but negatively predicts long-term returns. We offer a theoretical resolution to this dichotomy. In our model, career-concerned money managers interact with profit-motivated proprietary traders and security dealers endowed with market power. We show that the reputational concerns of fund managers imply an endogenous tendency to imitate past trades, which impacts the prices of the assets they trade. In our main result, we show that institutional herding positively predicts short-term returns but negatively predicts long-term returns. Our theory thus provides a simple and unified framework within which to interpret the empirical literature on the price impact of institutional herding. In addition, our paper generates several new testable predictions linking institutional herding behavior, trading volume, and the time-series properties of stock returns.
Keywords: Career concerns; Institutional herding; Price impact
JEL Codes: C7; G0
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| institutional herding (C92) | short-term returns (G12) |
| institutional herding (C92) | long-term returns (G12) |
| fund managers' reputational concerns (G23) | herding behavior (C92) |
| herding behavior (C92) | trading volume (G15) |
| herding behavior (C92) | price levels (E30) |
| buy herds (C92) | positive short-term returns (G12) |
| sell herds (Q12) | negative long-term returns (G12) |