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The Price Impact of Institutional Herding

Author

Listed:
  • Amil Dasgupta
  • Andrea Prat
  • Michela Verardo
Abstract
In this paper we develop a simple theoretical model to analyze the impact of institu- tional herding on asset prices. A growing empirical literature has come to the intriguing conclusion that institutional herding positively predicts short-term returns but nega- tively predicts long-term returns. We o¤er a theoretical resolution to this dichotomy. In our model, career-concerned money managers interact with pro?t-motivated proprietary traders and security dealers endowed with market power. We show that the reputational concerns of fund managers imply an endogenous tendency to imitate past trades, which impacts the prices of the assets they trade. In our main result, we show that institutional herding positively predicts short-term returns but negatively predicts long-term returns. Our theory thus provides a simple and uni?ed framework within which to interpret the empirical literature on the price impact of institutional herding. In addition, our paper generates several new testable predictions linking institutional herding behavior, trading volume, and the time-series properties of stock returns.

Suggested Citation

  • Amil Dasgupta & Andrea Prat & Michela Verardo, 2010. "The Price Impact of Institutional Herding," FMG Discussion Papers dp652, Financial Markets Group.
    • Handle: RePEc:fmg:fmgdps:dp652
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    References listed on IDEAS

    as
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    JEL classification:

    • C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory
    • G0 - Financial Economics - - General

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