Herd Behavior in Financial Market Essay Example for Free

displace Behavior in Financial Market EssayDefinition of droveingOn Friday 14 September 2007, when Yankee Rock in the UK opened it branches, many customers wanted to withdraw their savings and 1 billion, ab step forward 5% of the total bank deposits were withdrawn that day. And on Monday 17 September, a similar situation happened in figurehead of Northern Rock branches in the UK. plain though every customer does not have the uniform amount of teaching, they all decided to behave in the aforesaid(prenominal) focusing and some were followers the others on the following days without any clear plan. People thought that they were going to lose their bank deposits and that shell of bank customers appearance caused liquidity problem and made the situation even worse.However, none of the clients who kept their deposits muzzy collectible to the f symbolize the British Government and the blaspheme of England would guarantee the safety of the deposits. How can we explain tha t material body of behavior? Originally Herding is a term meaning animal flocking behavior. And according to the definition of Wikipedia Herding is the act of carry individual animals together into a class (herd), primary(prenominal)taining the group and moving the group from place to place-or any faction of those. Apart from this bank run case, Herd behavior describes how individuals in a group can act together without planned direction.POSSIBLE EXPLICATION AND MECHANISM OF HERD BEHAVIORAnimals Herd BehaviorAccording to evolutionary biologist W. D. Hamiltons theory animals be forming a group to reduce the danger of being hunted by predictors. As a unit, they are moving together to the same direction. Animals are behaving in the same way to minimize the risk on the behalf of self-protection. Maybe this kind of behavior sounds rational if the result is always affirmatory but copying your neighbor can be the worst decision sometimes. When something goes wrong and someone mel t downs the group to the wrong direction, the whole group is going to be in danger.Human Herd BehaviorHowever, valet de chambre herd behavior is much to a greater extent complicated than animals one and several(prenominal) scholars tried to explain it. Friedrich Nietzsche referred it as herd morality and the herd instinct which explain the phenomena when a lot of muckle are behaving in the same way at the same time. And according to Thorstein Veblens theory, some nation imitate the other people with higher status. Human beings are continuously competing with others in order to survive or surpass others, and they separate out to move faster in order to enlist advantage of the others. As the proverbs says the early bird catches the worm, they imagine the faster they make the decision or do whatever they can, the better it is. However, this does not always lead to success.Those decisions are ground on the sources they have and the sources areSanctions upon deviants dictators p ut their rivals in the prison (opposition is not allowed) discernment interactions some people are tearing Burberry coats just because the majority is wearing it while others prefer to wear coats with the colors they likeDirect communication someone from your reference group or someone with believability says that s/he likes certain productsObservational influence you observe the consequences of others actionsBased on such sources, people make decision whether to herd or disperse, but people are herding for different reasons and their behavior is class into several models.Herding ModelsPayoff Externalities Models (also called Network Externalities) If more people are using facebook, it go out attract more people to use facebook. In this case, people feel like they have to participate in the same situation so that they can have the same benefits.Information Cascade Models When you have a overgorge of information coming in, it is much more difficult to make a rational decisi on. Nowadays at that place are too many sources to consider and you can barely judge if information is true or false. In this kind of situation, people are getting irrational and they tend to make decision based on the decision of the majorities, and this situation is called information cascade which occurs when people observe the actions of others and then make the same choice that the others have made, independently of their own private information signals.They are seen in groups under nimble stress from external forces, such as herd behaviour. A cascade arises naturally when people ordinarily see what others do but not what they know. Because it is usually sensible to do what other people are doing, even this can be against what the individual believes to be true. This behavior is independent from their own private information or opinion.Concept of information cascade is based on observational and social e juvenileing. People learn from their environment. Generally, people ar e oriented to avoid minus consequences of their decisions or behaviors. They wish to have positive results or effects. Thats why their behavior is link up to social and observational learning. People subconsciously have the idea of It is more likely that I am wrong than that all those other people are wrong. Therefore, I will do as they do.Examples of Herding BehaviorBank runs depositors running on banks when they observe other depositors doing so. More specifically, basic investors can observe in long run when others are running on banks. Second, forcing long-term projects to consume early possibly leads to shortfall of funds.From the payoff externalities models view, people are withdrawing their deposits because they feel like they are losing their funds if they keep their money on the bank account. And from informational cascade models view, some people may think they are not going to lose their money on their bank account but they are following the others because they think they are not wise enough and others are withdrawing their money.In real case, Argentina undergo such a run in the last two days of November 2001, with total deposits in the banking clay falling by more than 2 billion (US) dollars, or nearly 3 percent, on the succor day of the run alone.1 Such runs were a common occurrence in the United States in the late nineteenth and early twentieth centuries and have also occurred in recent times in several developing countries, including Brazil in 1990 and Ecuador in 1999.Asian crisis of 97-98, herding and speculation infectionThe Asian crisis of 1997-98 that led to a regional economic fall in East Asia can be traced to overexpansion and under-regulation. The center of the Asian crisis was Thailands casual macroeconomic management that featured a fraudulent fiscal sector. The Asian expansion of the crisis was a due to the existing global financial integration (and similar export dependencies), modern account inequities and attached change over rates all mixed with the damaging effect of speculation and herding spreading all over the region. Resulting morphological system reforms and adjustments in Thailand and other damaged Asian nations came from the International Monetary Fund. A major result was a balanced exchange rate regime now prevalent in much of East Asia.FactsDuring 1995 a number of experts started to wonder if the countries of Southeast Asia might be vulnerable to a macroeconomic crisis do to the scummy administration of its financial procedures and to the volatility of their link economies. The main indicator was the rise of very hulky current account deficits among several Asian countries. Closer examination also revealed that several of the countries had developed some financial weaknesses heavy investment in highly speculative real estate ventures, financed by borrowing from hard informed foreign sources or by credit from non regulated domestic financial institutions. Its now cognise that during 1996 officials from the IMF and World Bank actually began warning the governments of Thailand, Malaysia, and other countries of the existing risks by their financial situation, and asked them to apply disciplinal policies. However, those governments rejected the warnings.On July 2 1997, after months of declaring that it would not happen, the government of Thailand abandoned its efforts to maintain a set(p) exchange rate for its money, the baht. The currentness was quickly depreciated by more than 20 percent so indoors a few days most neighboring countries fell like Thailand. What forced Thailand to devalue its currency was the massive speculation against the baht, assumptions that over a few months had consumed most of what initially seemed as a large war of foreign exchange. And why were speculators betting against Thailand? Because they expected the baht to be devalued, of course.This kind of circular logic in which investors escape a currency because they expect it to be de valued, and much of the pressure on the currency comes precisely because of this investor shortage of confidence is the defining actor of a currency crisis and is known as Bank Run theory. In the context of a currency crisis, such behavior could mean that a flutter of selling, whatever its initial cause, could be magnified through complete imitation and turn, into a rush out of the currency.Bank run in Thai currency devaluation can be viewed in two main behaviors. First investors run when other investors are running the bank a magnified opinion of a certain group starts to be spread in some others by just herding or imitation. Second, when banks that were invest in long-term projects were forced to liquidate early (because of the invertors running away), there was a potential lost(p) of funds. Consequently, the last depositors to withdraw were left empty-handed (first-come, first-served limitation).BUBBLESBubbles are sort of mass errors caused by the nature of herd. Even though there is a convincing examine of riffles, people are still overly convert by their belief that market is efficient and rational. Therefore people are optimistic of their investment and they take part in the bubble. Some people may doubt the situation and find some evidence of bubbles but they still invest their capital in the market because others are doing it which is a sort of informational cascade. However, the bubble collapses and that sort of herding behavior makes the impact of the collapse much significant.The Dot-com BubbleThe dot-com bubble (also referred to as the Internet bubble) was a speculative which had its climax on March 10, 2000, with the NASDAQ hitting up to 5132.52 but shutdown at 5048.62 in the same day. During the dot-com bubble period mostly the developed countries experienced the produce in the Internet sector and related fields.Companies such as Cisco Systems, Dell, Intel, and Microsoft were the dominant player of NASDAQ. And related to the Internet busi ness a group of new Internet-based companies commonly referred to as dot-coms were founded. Just because of the fact that Companies had a name with an e- prefix to their name and a .com the buy in price was going up. Investors were overly confident of their hereafter profits due to the advancement of technology and individual speculation while they overlooked traditional stock market value until the bubble was collapsed.ConclusionAs we can see massive herding behavior move out to be a cause of crisis at the end, and herd behavior is seen as something very negative to the market. As we have seen bank runs, bubbles, and several forms of crises. However, we cannot prevent from herding because it is a sort of instinct and it is closely related to psychological factors. Partially, individuals can make profit of their herding behavior as they are following famous investors such as Warren Buffet but the fact is that no investor can really avoid bubbles and see the coming crises. What w e have to remember is the financial market is a complex of rational and irrational behavior and we can barely categorize them before the disaster happens. We have to be prepared of the consequence the herd behavior and be rational when the irrationality happens.Works CitedBIKHCHANDANI, S., 1998, Learning from the behavior of others conformity, fads, and informational cascadesBIKHCHANDANI, S., D. HIRSHLEIFER and I. WELCH, 2001. Informational Cascades and logical Herding An AnnotatedDevenow, Andrea and Ivo Welch, 1996, Rational Herding in Financial Economics, European Economic Review 40, 603-615Ennis, Huberto M. and Todd Keister, 2009, Bank Runs and Institutions The Perils of Intervention.Hirshleifer, David and Teoh, Siew Hong, 2011, Herd Behavior and Cascading in Capital Markets A Review and Synthesis, MPRA Paper No. 5186