The Effect of Monetary Policy on Herd Behavior During Financial Crises

Abstract

Monetary policy actions (conventional and unconventional) are important events that are expected to affect asset prices, especially during periods of financial turmoil. Although many studies examine their effect on asset prices there is a lack of empirical evidence on their impact on investor herd behaviour. We examine the effect of European Central Bank (ECB) monetary policy, both conventional and unconventional, on equity market herd behaviour for seven Eurozone markets during the subprime and the EU financial crises. We combine a range of research methodologies to measure herd behaviour and unconventional policies, such as the Qual-Var model of Dueker (2005), the structural Factor-Augmented Vector AutoRegression model, 266 variables for the sample markets, and the herd behaviour measure of Hwang and Salmon (2009). Our results indicate that monetary policy decisions, conventional and unconventional, have an effect on herd behavior during a financial crisis, with the effect being more pronounced for certain markets and for unconventional policies. In addition, the effect of a shock of monetary policy on herding results to higher levels of herd behaviour for Spain, Italy, France, and Portugal.