The profitability of herding: evidence from Taiwan

Abstract

Purpose The purpose of this paper is to show that the level of herding in an industry can be the basis for a profitable investment strategy. Design/methodology/approach The authors apply three different herding measures in the paper, including cross-sectional standard deviation, cross-sectional absolute deviation and non-linear model – state–space model. Findings The authors find that industries that experience a high level of herding yield higher subsequent returns regardless of their past performance. Consequently, the authors show that a herding-based investment strategy generates significant profits, even after adjusting for risk. The findings also show that the herding effect when combined with past performance as part of a conditional investment strategy yields significant profits regardless of the formation and holding periods. The findings suggest that the level of herding could serve as a systematic driver of returns and could be exploited for profitable investment strategies. Originality/value To the best of authors’ knowledge, this is the first study in the literature to show that herding by itself can serve as a determinant of returns regardless of past performance.

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