Monday, June 27, 2011

Industry Herding and Momentum

[Authors: Zhipeng Yan, School of Management, New Jersey Institute of Technology; Yan Zhao, Economics Department, City College of New York-CUNY]

Theoretical models on herd behavior predict that under different assumptions, herding can bring prices away (or towards) fundamentals and reduce (or enhance) market efficiency. In this article, we study the joint effect of herding and momentum at the industry level. We find that the momentum effect is magnified when there is a low level of investor herding. Herd behavior in investors help move asset prices towards fundamentals and enhance market efficiency. A trading strategy taking a long position in winner industries and a short position in loser industries when the herding level is low can generate significant returns.

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