Herding behavior and stock market conditions

Abdollah Ah Mand,Hawati Janor,Ruzita Abdul Rahim,Tamat Sarmidi

doi:10.1108/prr-10-2020-0033

Abdollah Ah Mand, Hawati Janor + Show 2 more

Open Access

https://doi.org/10.1108/prr-10-2020-0033

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Abstract

Purpose The purpose of this paper is to investigate whether market conditions have an effect on investors’ propensity to herd in an emerging economy’s stock market. Additionally, given the lack of research on Islamic behavioral finance, the authors further investigate if the herding phenomenon is distinct in Islamic versus conventional stocks. Design/methodology/approach The authors used daily data for the period of 1995–2016 according to the herding behavior model of Chang et al. (2000), which relies on cross-sectional absolute deviation of returns. Findings Findings reveal the herding behavior of investors among Shariah-compliant during up and down market exits with non-linear relationship to the market return, while for conventional stocks herding behavior does not exist with linear nor nonlinear relationships during the up and down market. Furthermore, for the whole market, herding behavior only exists during upmarket with a nonlinear relationship to the market return. However, this relationship is not significant. Moreover, the results of this study are robust with respect to the effect of the Asian and global financial crisis. Practical implications The findings are useful for investors to identify which market conditions are associated with rational and irrational behavior of investors. Originality/value Most of the theoretical and empirical studies on herding behavior have focused on developed countries. Only a few studies have paid attention to the herding behavior in Islamic financial markets, particularly in the context of an emerging market such as Malaysia. This study fills this void.

Highlights

Stock markets are reflectors of the financial status of a country
Following the methodology of model on herding behavior of Christie and Huang (1995), the stocks which their return distribution leans among the 5% lower tail of return distribution of sample is classified as a market down and stocks on which their return laying among 5% upper tail of return distribution of sample is classified into upmarket conditions
Current study investigates the relationship of herding behavior of investors with market return during up and down market among Malaysian investors for the period of 1995–2016 by using daily data

Summary

Introduction

Stock markets are reflectors of the financial status of a country. As such, if the outlook of stock market is stable; it portrays that the economic situation of the country is good and vice versa. Series of studies have shown that behavioral elements play a significant role in determining market prices This view is contradicting the traditional finance theories (Scharfstein and Stein, 1990; Chen et al, 2003; Demirer and Kutan, 2006). As herding behavior theory says, the investors who tend to herd would avoid their own private information and, in the process, cause to place the prices in a position away from the intrinsic values. This could cause the markets to be volatile (Balcilar et al, 2013)

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