Institutional herding and its price impact: Evidence from the corporate bond market

Abstract

Among growing concerns about potential financial stability risks posed by the asset management industry, herding has been considered as an important risk amplification channel. In this paper, we examine the extent to which institutional investors herd in their trading of U.S. corporate bonds and quantify the price impact of such herding behavior. We find that, relative to what is documented for the equity market, the level of institutional herding is much higher in the corporate bond market, particularly among speculative-grade bonds. In addition, mutual funds have become increasingly likely to herd when they sell, a trend not observed among insurance companies and pension funds. We also show that bond investors herd not only within a quarter, but also over adjacent quarters. Such persistence in trading is largely driven by funds imitating the trading behavior of other funds in the previous quarter. Finally, we find that there is an asymmetry in the price impact of herding. While buy herding is associated with a permanent price impact that is consistent with price discovery, sell herding results in transitory yet significant price distortions. The price destabilizing effect of sell herding is particularly strong for high-yield bonds, small bonds, and illiquid bonds and during the recent global financial crisis.

From COVID-19 herd immunity to investor herding in international stock markets: The role of government and regulatory restrictions

“…Herding behaviour is regarded to have been a catalyst of the Global Financial Crisis ( Galariotis et al, 2016 ), stock price instabilities ( Cai et al, 2019 , Kremer and Nautz, 2013 ), stock price bubbles and other anomalies ( Devenow and Welch, 1996 , Hott, 2009 ), but only if herding is driven by non-information based reasons ( Choi & Skiba, 2015 ). Herding behaviour can also lead to an increase in the degree of co-movement among financial asset returns, which reduces the benefits of portfolio diversification ( Economou et al, 2011 ).…”

Herding Behaviour in Investment Decision Making: A Review

“…The institutional buy herding is consistent with price determination and sell herding is consistent with price distortions and is stronger for high yielding bonds, small bonds and illiquid bonds during the financial crisis [33].…”

“…When investors herd to sell, the stock prices fall significantly during that period but reverse slowly over upcoming quarters. This result is true in equity market [40,28,26,23] but is much stronger in magnitude in institutional market [33]. The price destabilizing effect of sell herding was found to be particularly strong for high-yield bonds, small bonds, and illiquid bonds and during the recent global financial crisis [33].…”

Seventy-Five Years of Investing for Future Generations

“…In addition, reputational concerns can lead fund managers to imitate past trades (Dasgupta, Prat, and Verardo 2011). Herding behavior has been examined among various types of institutional investors, such as pension funds (Blake, Sarno, and Zinna 2017) and passive funds (Fisch, Hamdani, and Solomon 2019), on the part of investor cliques (Crane, Koch, and Michenaud 2019), and in futures markets (Boyd, Büyükşahin, Haigh, and Harris 2016) and bond markets (Cai, Han, Li, and Li 2019).…”