Shepherding the Herd

Abstract

This article analyzes multiple agents who forecast an underlying dynamic state based on streams of (partially overlapping) information. Each agent minimizes a convex combination of their forecasting error and deviation from the other agents' forecasts. As a result, the agents exhibit herding behavior - a bias that has been well-recognized in the economics and psychology literature. Our first contribution is a general framework for analyzing agents' forecasts under different levels of herding. The underlying state dynamics can be non-linear with seasonality, trends, shocks, or other time-series components. Our second contribution describes how models within our framework can be estimated from data. We apply our estimation procedure to surveys of equity price forecasts and find that the agents concentrate on average 37% of their efforts on making similar forecasts. However, there is substantial variation in the level of herding over time; even though herding falls substantially during the 2007-2008 financial crisis, it rises after the crisis.