Herding or reverse herding: the reaction to change in investor sentiment in the Chinese and Pakistani markets

Muhammad Fayyaz Sheikh · Aamir Inam Bhutta · Tahira Parveen

22 citations0/0 files storedInternational Journal of Emerging Markets

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Financial Markets and Investment Strategies Financial Risk and Volatility Modeling Stock Market Forecasting Methods

Abstract

Purpose Investor sentiment (optimism or pessimism) may influence investors to follow others (herding) while taking their investment decisions. Herding may result in bubbles and crashes in the financial markets. The purpose of the study is to examine the presence of herding and the effects of investor sentiment on herding in China and Pakistan. Design/methodology/approach The investor sentiment is captured by five variables (trading volume, advance/decline ratio, weighted price-to-earnings ratio, relative strength index and interest rates) and a sentiment index developed through principal component analysis (PCA). The study uses daily prices of 2,184 firms from China and 568 firms from Pakistan for the period 2005 to 2018. Findings The study finds that herding prevails in China while reverse herding prevails in Pakistan. Interestingly, as investors become optimistic, herding in China and reverse herding in Pakistan decrease. This indicates that herding and reverse herding are greater during pessimistic periods. Further, the increase in herding in one market reduces herding in the other market. Moreover, optimistic sentiment in the Chinese market increases herding in the Pakistani market but the reverse is not true. Practical implications Considering the greater global financial liberalization, and better opportunities for emotion sharing, this study has important implications for regulators and investors. Market participants need to understand the prevalent irrational behavior before trading in the markets. Originality/value Since individual proxies may depict different picture of the relationship between sentiment and herding therefore the study also develops a sentiment index through PCA and incorporates this index in the analysis. Further, this study examines cross-country effects of herding and investor sentiment.

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References

1970EFFICIENT CAPITAL MARKETS: A REVIEW OF THEORY AND EMPIRICAL WORK*1992Sequential Sales, Learning, and Cascades 2000An examination of herd behavior in equity markets: An international perspective 1995Following the Pied Piper: Do Individual Returns Herd around the Market?2003Herd Behaviour and Cascading in Capital Markets: a Review and Synthesis 2010An empirical analysis of herd behavior in global stock markets 1992A Mean/Variance Analysis of Tracking Error 1994Security Analysis and Trading Patterns When Some Investors Receive Information Before Others

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