Herding, Information Cascades and Volatility Spillovers in Futures Markets

Authors

  • Michael McAleer National Tsing Hua University
  • Kim Radalj University of Western Australia

DOI:

https://doi.org/10.6000/1929-7092.2013.02.23

Keywords:

Herding, speculation, hedging, noise traders, currency and commodity markets, futures and spot markets, time-varying volatility, causality-in-variance, spillovers

Abstract

Economists and financial analysts have begun to recognise the importance of the actions of other agents in the decision-making process. Herding is the deliberate mimicking of the decisions of other agents. Examples of mimicry range from the choice of restaurant, fashion and financial market participants, to academic research. Herding may conjure negative images of irrational agents sheepishly following the actions of others, but such actions can be rational under asymmetric information and uncertainty. This paper uses futures position data in nine different markets of the Commodity Futures Trading Commission (CFTC) to provide a direct test of herding behaviour, namely the extent to which small traders mimic the positions of large speculators. Evidence consistent with herding among small traders is found for the Canadian dollar, British pound, gold, S&P 500 and Nikkei 225 futures. Consistent with survey-based results on technical analysis, the positions are significantly correlated with both current and past market returns. Using various time-varying volatility models to accommodate conditional heteroskedasticity, the empirical results are found to be robust to alternative models and methods of estimation. When a test of causality-in-variance is used to analyse if volatility among small traders spills over into spot markets, it is found that spillovers occur only with Nikkei 225 futures. The policy implications of the findings are also discussed.

Author Biographies

Michael McAleer, National Tsing Hua University

Department of Quantitative Finance

Kim Radalj, University of Western Australia

Department of Economics

References

Asch, S. (1952), Social Psychology, Englewood Cliffs, New Jersey, Prentice-Hall.
http://dx.doi.org/10.1037/10025-000
Admati A. and P. Pfleiderer (1997), ‘Does It All Add Up? Benchmarks and the Compensation of Active Portfolio Managers’, Journal of Business, 70, 323-350.
http://dx.doi.org/10.1086/209721
Avery, C. and P. Zemsky (1998), ‘Multidimensional Uncertainty and Herd Behavior in Financial Markets’, American Economic Review, 88, 724-748.
Banerjee, A. (1992), ‘A Simple Model of Herd Behavior’, Quarterly Journal of Economics, 107, 797-818.
http://dx.doi.org/10.2307/2118364
Becker, G.S. (1991), ‘A Note on Restaurant Pricing and Other Example of Social Influence on Price’, Journal of Political Economy, 99, 1109-1116.
http://dx.doi.org/10.1086/261791
Bessembinder, H. and P.J. Seguin (1992), ‘Futures-Trading Activity and Stock Price Volatility’, Journal of Finance, 47, 2015-2034.
http://dx.doi.org/10.1111/j.1540-6261.1992.tb04695.x
Bikhchandani, S., D. Hirshleifer and I. Welch (1992) ‘A Theory of Fads, Fashion, Custom and Cultural Change as Informational Cascades’, Journal of Political Economy, 100, 992-1026.
http://dx.doi.org/10.1086/261849
Bikhchandani, S., D. Hirshleifer and I. Welch (1998) ‘Learning from the Behavior of Others: Conformity, Fads and Informational Cascades’, Journal of Economic Perspectives, 12, 151-170.
http://dx.doi.org/10.1257/jep.12.3.151
Bikhchandani, S. and S. Sharma, (2000) ‘Herd Behavior in Financial Markets: A Review’, IMF Working Paper, WP/00/48.
Black, F. (1986), ‘Noise’, Journal of Finance, 41, 529-543.
http://dx.doi.org/10.1111/j.1540-6261.1986.tb04513.x
Bollerslev, T. (1986), ‘Generalized Autoregressive Conditional Heteroskedasticity’, Journal of Econometrics, 31, 307-327.
http://dx.doi.org/10.1016/0304-4076(86)90063-1
Bollerslev, T. and J.M. Wooldridge (1991), ‘Quasi Maximum Likelihood Estimation and Inference in Dynamic Models with Time-Varying Covariances’, Econometric Reviews, 11, 143-172.
http://dx.doi.org/10.1080/07474939208800229
Bollerslev, T., R.Y. Chou and K.F. Kroner (1992), ‘ARCH Modeling in Finance: A Review of the Theory and Empirical Evidence’, Journal of Econometrics, 52, 5-59.
http://dx.doi.org/10.1016/0304-4076(92)90064-X
Bollerslev, T., R.F. Engle and D.B. Nelson (1994), ‘ARCH Models’, in R.F. Engle and D.L. McFadden (eds.), Handbook of Econometrics, Vol. 4, Amsterdam, Elsevier, 2959-3038.
Brunnermeier, M.K. (2001), Asset Pricing under Asymmetric Information: Bubbles, Crashes, Technical Analysis and Herding, Oxford University Press, New York.
http://dx.doi.org/10.1093/0198296983.001.0001
Caporin, M. and M. McAleer (2012), ‘Model selection and testing of conditional and stochastic volatility models’, in L. Bauwens, C. Hafner and S. Laurent (eds.), Handbook on Financial Engineering and Econometrics: Volatility Models and Their Applications, Wiley, New York, pp. 199-222.
http://dx.doi.org/10.1002/9781118272039.ch8
Chang, E.C., J.W. Cheng and A. Khorana (2000) ‘An Examination of Herd Behavior in Equity Markets: An International Perspective’, Journal of Banking and Finance, 24, 1651-1679.
http://dx.doi.org/10.1016/S0378-4266(99)00096-5
Christie, W.G. and R.D. Huang (1995), ‘Following the Pied Piper: Do Individual Returns Herd Around the Market?’, Financial Analysts Journal, 51, 31-37.
http://dx.doi.org/10.2469/faj.v51.n4.1918
Choe, H., B. Kho and R.M. Stulz (1999) ‘Do Foreign Investors Destabilize Stock Markets?’, Journal of Financial Economics, 54, 227-264.
http://dx.doi.org/10.1016/S0304-405X(99)00037-9
de Brouwer, G. (2001), Hedge Funds in Emerging Markets, Cambridge University Press, Cambridge.
http://dx.doi.org/10.1017/CBO9780511493331
De Long, J.B., A. Shleifer, L.H. Summers and R.J. Waldmann, (1990a), ‘Positive Feedback Investment Strategies and Destabilizing Rational Speculation’, Journal of Finance, 45, 379-395.
http://dx.doi.org/10.2307/2328662
De Long, J.B., A. Shleifer, L.H. Summers and R.J. Waldmann (1990b), ‘Noise Trader Risk in Financial Markets’, Journal of Political Economy, 98, 703-738.
http://dx.doi.org/10.1086/261703
Devenow, A. and I. Welch (1996) ‘Rational Herding in Financial Economics’, European Economic Review, 40, 603-615.
http://dx.doi.org/10.1016/0014-2921(95)00073-9
Engle, R.F. (1982), ‘Autoregressive Conditional Heteroskedasticity with Estimates of the Variance of United Kingdom Inflation’, Econometrica, 50, 987-1007.
http://dx.doi.org/10.2307/1912773
Froot, K.A., D.S. Scharfstein and J.C. Stein (1992), ‘Herd on the Street: Informational Inefficiencies in a Market with Short-Term Speculation’, Journal of Finance, 47, 1461-1484.
http://dx.doi.org/10.1111/j.1540-6261.1992.tb04665.x
Glosten, L., R. Jagannathan and D. Runkle (1993), ‘On the Relation Between the Expected Value and the Volatility of Nominal Excess Return on Stocks’, Journal of Finance, 48, 1770-1801.
http://dx.doi.org/10.1111/j.1540-6261.1993.tb05128.x
Graham, J.R. (1999), ‘Herding Among Investment Newsletters: Theory and Evidence’, Journal of Finance, 54, 237-268.
http://dx.doi.org/10.1111/0022-1082.00103
Grinblatt, M., S. Titman and R. Wermers (1995), ‘Momentum Investment Strategies, Portfolio Performance and Herding: A Study of Mutual Fund Behavior’, American Economic Review, 85, 1088-1105.
Hong, Y. (2001), “A Test for Volatility Spillover with Application to Exchange Rates’, Journal of Econometrics, 103, 183-224.
http://dx.doi.org/10.1016/S0304-4076(01)00043-4
Keynes, J.M. (1936), General Theory of Employment, Interest and Money, Macmillan, London.
Kodres, L. and M. Pritsker (1996), ‘Directionally-Similar Position Taking and Herding by Large Futures Markets Participants’, in Risk Measurement and Systematic Risk: Proceedings of a Joint Central Bank Research Conference, Board of Governors of the Federal Reserve, 221-272.
Kyle, A.S. (1985), ‘Continuous Auctions and Insider Trading’, Econometrica, 53, 1315-1336.
http://dx.doi.org/10.2307/1913210
Lakonishok, J., A. Shleifer and R.W. Vishny (1992), ‘The Impact of Institutional Trading on Stock Prices’, Journal of Financial Economics, 32, 23-43.
http://dx.doi.org/10.1016/0304-405X(92)90023-Q
Li, W.K., S. Ling and M. McAleer (2002), ‘Recent Theoretical Results for Time Series Models with GARCH Errors’, Journal of Economic Surveys, 245-270. Reprinted in M. McAleer and L. Oxley (eds.), Contributions to Financial Econometrics: Theoretical and Practical Issues, Blackwell, Oxford, 2002, pp. 9-33.
McAleer, M. (2005), ‘Automated inference and learning in modeling financial volatility’, Econometric Theory, 21, 232-261.
http://dx.doi.org/10.1017/S0266466605050140
McAleer, M., F. Chan and D. Marinova (2007), ‘An Econometric Analysis of Asymmetric Volatility: Theory and Application to Patents’, Journal of Econometrics, 139, 259-284.
http://dx.doi.org/10.1016/j.jeconom.2006.10.014
Neftci, S.N. (1996), An Introduction to the Mathematics of Financial Derivatives, Academic Press, San Diego.
Nelson, D.B. (1990), ‘Conditional Heteroskedasticity in Asset Returns: A New Approach’, Econometrica, 59, 347-370.
http://dx.doi.org/10.2307/2938260
Newey, W. and K. West (1987), ‘A Simple Positive Semi-definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix’, Econometrica, 55, 703-708.
http://dx.doi.org/10.2307/1913610
Nofsinger, J.R., and R.W. Sias (1999), ‘Herding and Feedback Trading by Institutional and Individual Investors’, Journal of Finance, 54, 2263-2295.
http://dx.doi.org/10.1111/0022-1082.00188
Roll, R., (1992), ‘A Mean-Variance Analysis of Tracking Error’, Journal of Portfolio Management, 18, 465-479.
http://dx.doi.org/10.3905/jpm.1992.701922
Scharfstein, D. and J. Stein (1990), ‘Herd Behavior and Investment’, American Economic Review, 80, 465-479.
Schwert, G.W. and P.J. Seguin, (1993), ‘Securities Transaction Taxes: An Overview of Costs, Benefits and Unresolved Questions’, Financial Analysts Journal, 49, 27-35.
http://dx.doi.org/10.2469/faj.v49.n5.27
Shalen, C.T. (1993), ‘Volume, Volatility, and the Dispersion of Beliefs’, Review of Financial Studies, 6, 405-434.
http://dx.doi.org/10.1093/rfs/6.2.405
Shephard, N. (1996), ‘Statistical Aspects of ARCH and Stochastic Volatility’, in O.E. Barndoff-Nielsen, D.R. Cox and D.V. Hinkley (eds.), Statistical Models in Econometrics, Finance and Other Fields, Chapman & Hall, London, pp. 1-67.
Shiller, R.J. (1995), ‘Rhetoric and Economic Behavior: Conversation, Information and Herd Behavior’, American Economic Review, 85, 181-185.
Welch, I. (1992), ‘Sequential Sales, Learning and Cascades’, Journal of Finance, 47, 695-732.
http://dx.doi.org/10.1111/j.1540-6261.1992.tb04406.x
Welch, I. (2000), ‘Herding Among Security Analysts’, Journal of Financial Economics, 58, 369-396.
http://dx.doi.org/10.1016/S0304-405X(00)00076-3
Wermers, R. (1999), ‘Mutual Fund Herding and the Impact on Stock Prices’, Journal of Finance, 54, 581-622.
http://dx.doi.org/10.1111/0022-1082.00118

Downloads

Published

2013-07-29

How to Cite

McAleer, M., & Radalj, K. (2013). Herding, Information Cascades and Volatility Spillovers in Futures Markets. Journal of Reviews on Global Economics, 2, 307–329. https://doi.org/10.6000/1929-7092.2013.02.23

Issue

Section

Articles

Most read articles by the same author(s)

1 2 > >>