Abstract
The characteristics of the Portuguese stock market suggest that it is susceptible to herding behaviour. We investigate the existence of this behaviour in Portugal during periods of market stress, with emphasis on the subprime and European sovereign debt crises. We analyse the overall stock market, key industries, and portfolios divided by market capitalisation. The study is performed using both linear and nonlinear models, and the impact of conditional variance is taken into account. This paper shows evidence of herding behaviour when the nonlinear model is used and during periods of crisis. Investors imitate more assets of similar size than assets of the same industry. Finally, the evidence of herding behaviour is reduced when GARCH effects are taken into account.
Highlights
The instability of Financial markets is a much-discussed topic and many researchers have studied its causes and consequences
Looking at the evolution of PSI 20 (Graph 1), we observe a sharp decline in the index during the subprime crisis followed by a recovery in 2009, which is interrupted by a new period of decline at the beginning of 2010
For the coefficients of the subprime crisis, the Wald test (p-value = 0.00) shows the existence of herding behavior. These results suggest that the sovereign debt crisis and mostly the Subprime crisis created herding behavior, contrary to other studies
Summary
The instability of Financial markets is a much-discussed topic and many researchers have studied its causes and consequences. Some economic theory suggests that prices efficiently reflect rational agents' expectations (Scharfstein and Jeremy, 1990). Investors may be forced to negotiate at inefficient prices (Christie and Huang, 1995), due, for instance, to group psychology, i.e. herding behavior (Scharfstein and Jeremy, 1990). Herding may not be intentional, and may be caused by correlation of independent behaviors due to information disclosure - "spurious herding" (Bikhchandani and Sharma, 2000). Another phenomenon close to herding behavior is fire sales, where investors sell assets at very low prices accumulating huge losses (Shleifer and Vishny, 2011)
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