Herding behaviour of institutional investors is the trading of securities in the same direction as similar groups of investors. Institutional investors herd for various reasons, including reputational risk, lack of confidence, and due to fads. This study examines if herding behaviour exists in the modern economy where global financial markets have evolved, mainly due to financial innovation and the presence of more sophisticated investors. We find that herding behaviour is evident even after 40 years when the first study of ‘herding’ was reported. With the recent Global Financial Crisis (GFC), more attention has been given to financial markets. In our study, we examine the relation between herding and different market states.
Firstly, the level of institutional herding is compared in different markets. Our findings exhibit higher magnitude of herding during market downturns as opposed to up-markets. We suggest investors are reluctant to realize losses based on their own independent decision. Following their peers, who are also professional investors themselves, is preferable to making a wrong trading decision alone.
We then extend the literature by determining the potential ‘causal’ relation between herding and different market conditions. To do so, we employ the Granger causality test and an instrumental variables approach. The latter approach mitigates the endogeneity issue between herding and market returns which we use to proxy market conditions. Our findings show that a lag and lead relation between institutional herding and market returns exist.