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Herding Behavior in an Emerging Stock Market:

Empirical Evidence from India


Ashish Garg* and Kiran Jindal**
This paper is an attempt to examine the presence of herd behavior in the stock market of India, which is one of the
emerging economies of the world. The study uses the measures suggested by Christie and Huang (1995) and Chang
et al. (2000) on National Stock Exchange data. Empirical results based on daily and monthly data indicate that during
periods of extreme price movements, equity return dispersions tend to increase rather than decrease, thus providing
evidence against the presence of herding in the Indian stock market for the years 2000-2012. Owing to reforms in
Indian stock market and the increased presence of institutional players, investors behavior seems to be more rational,
facilitating the application of rational pricing models in the Indian stock markets.

Introduction
The history of the stock market shows that most investors buy stocks in companies or mutual
funds for presumably sound reasons but exit their holdings the moment the market turns
against them. They sell when a bunch of complete strangers offer them less than what they
had paid for their investment. Conversely, they pay high prices for stocks just because other
people whom they do not know, are willing to pay such prices. The dotcom boom was a result
of such thinking. In the stock market parlance, this is known as investing with the herd or
herding behavior. It is a phenomenon in which less sophisticated investors imitate market
gurus or seek advice from victorious investors with a mind setup that using their own
information will incur less benefits and more cost. Banerjee (1992) viewed herding as everyone
doing what everyone else was doing, even when their information suggested doing something
different.
Herd behavior happens when all investors copy the opinions of others to modify their
private beliefs. It is a response task complexity created by constraints of time, information or
ability. According to Cote and Sanders (1997), various factors which may influence herding
include concern over ones reputation, forecast ability, perceived credibility of the consensus
forecast and the variance among the individual opinions comprising the consensus forecast.
Theoretically, herd behavior has two types of views: rational and irrational. The rational
view advocates that individuals may rationally herd others whom they believe to be better
informed in comparison to the market. Rook (2006) believed that herding is rational and
subconscious but linked to a human need for conformity. On the other hand, when an
*

Assistant Professor, Indian Institute of Management Raipur, GEC Campus, Sejbahar, Raipur 492015,
Chhattisgarh, India. E-mail: ashish_mcom@rediffmail.com

**

Assistant Professor, MCM


E-mail: jindalkiran@gmail.com

2014 IUP. All Rights Reserved.


18

DAV

College

for

Women,

Sector

36,

Chandigarh,

India.

The IUP Journal of Applied Finance, Vol. 20, No. 2, 2014

investor behaves like a lemming and foregoes rational analysis, it leads to irrational herd
behavior. According to Christie and Huang (1995), herding is a tendency of investors who
irrationally ignore their own analysis and information and conform to the market consensus,
even if they do not agree with it. Investors do so because it reduces their uncertainty and
fulfills their need to feel confident (Vaughan and Hogg, 2005). Both explanations of herding
behavior highlight that investors do not follow their own beliefs and analysis, but follow the
market consensus.
The herd behavior of the investors results in trading in the market in the same direction
over a period of time, thereby destabilizing the market. It moves the securities away from
their fundamental value as share prices do not reflect the investors rational expectations of
the shares and also their irrational decisions (Nofsinger and Sias, 1999; Chang et al., 2000;
and Demirer et al,. 2007). Herding behavior has been linked to market inefficiency which
cannot be explained by the rational asset pricing models. Thus, in the presence of herding
behavior, all the theories based on the assumption of the efficient stock market will become
invalid. On the other hand, it may result in low abnormal return due to biased earnings
estimates and reduced risk perception.

Literature Review
Since the 1990s, researchers have devoted extensive efforts to investigate the level of herding
behavior in various stock markets in developed as well as developing markets. The theoretical
studies concentrated on the explanation of what might trigger herd behavior (Scharfstein
and Stein, 1990; Devenow and Welch, 1996; and Bikchandani and Sharma, 2001), while the
empirical studies focused on testing the effect that herding has on financial markets. One
strand of the empirical literature shows weak or no evidence of herding over the markets
(Lakonishok et al., 1991; Christie and Huang, 1995; Chang et al., 2000; Henker et al., 2006;
Lin and Swanson, 2008; Fu and Lin, 2010; and Khoshsirat and Salari, 2011). On the other
hand, several studies have examined the herding behavior in various stock markets and
found the existence of high degree of herding (Nofsinger and Sias, 1999; Wermers, 1999;
Hwang and Salmon, 2001; Batra, 2003; Caparrelli et al., 2004; Iihara et al., 2004; Zhou, 2007;
Agudo et al., 2008; Caporale et al., 2008; Hachicha et al., 2008; Tan et al., 2008; Andronikidi
and Kallinterakis, 2010; Demirer et al., 2010; Naoui, 2010; Chiang et al., 2011; Hsieh et al.,
2011; Kapusuzoglu, 2011; Khan et al., 2011; Kremer, 2011; Lakshman et al., 2011; Lao and
Singh, 2011; Sonaer, 2011; My and Truong, 2011; Zhao, 2011; Patro and Kanagaraj, 2012; and
Mabrouk and Mohamed, 2013).
The Indian stock market has long been criticized as an inefficient market due to the
incomplete laws and their weak enforcement, cultural differences, less educated investors
and low level of information disclosure. These could result in herding behavior and other
market anomalies. The research efforts to examine whether institutional herding exists in
the Indian stock market are in its infancy. The first of this kind of study was conducted by
Batra (2003) who concluded that foreign investors do herd together in their trading activity
in India. A study by Lao and Singh (2011), using Indian and Chinese Stock Markets data,
Herding Behavior in an Emerging Stock Market: Empirical Evidence from India

19

concluded that herding behavior is greater when the market was falling and the trading
volume was high in the case of Chinese markets. Moreover, they found the occurrence of
herding during upswings in the Indian markets. Lakshman et al. (2011) found the existence of
herding bias in the investment pattern of mutual funds and foreign institutional investors in
the Indian stock market. Sonaer (2011) documented that mutual funds in India follow herding
and they outperform in the market by joining herding. Patro and Kanagaraj (2012) also
reported a high level of herding in the Indian stock market as compared to developed markets.
However, all of these studies examined the herding behavior of mutual fund industry rather
than of stock market in totality. Moreover, the research evidence on herd behavior in the
Indian stock market is very limited. Therefore, the present study is an attempt to examine
the level of herding in the Indian stock market, which can provide a deeper understanding
regarding price formation in the Indian stock markets. This paper contributes to the existing
body of literature by analyzing the herding behavior over a period of time, highlighting the
current preference of investors for herding in the dynamic Indian financial market.

Methodology and Data


Methodology
In an informally efficient market, changes in the stock market index for a country should
reflect the investors reaction to information relevant to that particular countrys stock
market. However, during periods of abnormal informational flows and volatility, investors
tend to herd by ignoring their own information and instead rely on the aggregate market to
form their investment decision (Demirer et al., 2007). Therefore, to test the existence of
herding, two basic approaches have been developed by the researchers: (1) Analyzing the
tendency of the individuals or institutional investors like mutual funds and Foreign
Institutional Investors (FIIs) to follow each other and trade an asset at the same time; and (2)
Examining the collective behavior of all participants at the same time, thereby analyzing the
buying and selling of a particular asset at the same time.
In tune with the first approach, Lakonishok-Schleifer-Vishny (LSV, 1991) developed their
model to ascertain herding as the average tendency of all fund managers to buy and sell a
particular stock simultaneously in relation to what would be expected if the managers traded
independently. In terms of LSV measure, herding means a statistical trading correlation of a
particular group of market participants. It measures herding by studying a subset of market
participants over a specific period of time by looking at their quarter-end holdings and
treating change in each quarter as an observation. The herding measure for stock i in period
t is defined as follows:

H i,t | pi,t E[ pi,t ]| AFi,t

...(1)

where pi,t is the proportion of managers who had a net purchase in stock i during period t:

p i ,t
20

Nbr institutions buying i,t (Bi,t )


Nbr institutions buying i,t Nbr institutions selling i,t (Si,t )
The IUP Journal of Applied Finance, Vol. 20, No. 2, 2014

and AFi,t E[| p i,t E[ p i,t ]|] is the adjustment factor. Specifying the null hypothesis as no
herding, Hi,t is expected to be calibrated to zero, if no herding actually exists.
Several researchers criticized LSV model on various grounds as the measure is not able to
differentiate between intentional herding and unintentional herding (Bikhchandani and
Sharma, 2001). Moreover, it assumes the distribution to be a binomial distribution for Bi,t
when it is actually left truncated (Wylie, 2005), and this assumption causes another problem
as the propensity of fund managers to buy a stock is invariant for all stocks. However, the
propensity to buy may be conditioned by both the size of the initial holdings and net fund
flows under actual market conditions. Despite these shortcomings, LSV is still one of the
prominent models to measure herding. Domestic and FIIs trading data is not easily available
in the Indian context, so the present study focuses on the market-wide approach of detecting
the herd behavior in the Indian stock market by employing the models proposed by Christie
and Huang (1995) (CH) and Chang, Cheng and Khorana (2000) (CCK).
CH concluded that rational asset pricing models predict that the dispersion of securities
trading will increase with absolute value of the market return as individual assets differ in
their sensitivity to the market return. On the other hand, in the presence of herding, security
return will not deviate too far from the overall market return as investors suppress their
individual belief and tend to invest based on the collective action of the market. This behavior
will result in an increasing dispersion but at a decreasing rate, and if the herding is very severe
in the market, it may cause a decrease in dispersion. In order to quantify the dispersion which
measures the average proximity of individual returns to realized average, CH suggested the
use of Cross-Sectional Standard Deviation (CSSD) of single stock returns with respect to
market return that is defined as:

CSSD t

( R i,t R m,t )2

i 1

N 1

...(2)

where Ri,t is the observed stock return of firm i at time t and Rm,,t is the cross-sectional average
of the N returns in the aggregate market portfolio at time t.
CH suggested that herding is prevalent during the period of market stress, which can be
quantified with the occurrence of extreme returns on the market portfolio during that time
period. They used the following equation in their empirical specification:

CSSD t 1D tL 2 D U
t et

...(3)

where CSSD is the cross-sectional standard deviation, coefficient denotes the average
dispersion of the sample excluding the regions corresponding to the two dummy variables,
DtL is the dummy variable at time t taking on the value unity when the market return at time
t lies in the extreme lower tail of the distribution and otherwise 0. Similarly, DtU is the dummy
variable at time t taking on the value unity when the market return at time t lies in the
Herding Behavior in an Emerging Stock Market: Empirical Evidence from India

21

extreme upper tail of the distribution and otherwise 0. According to the model, statistically
significant negative value of 1 and 2 in Equation (2) indicates the presence of herding. The
present study uses 1%, 5% and 10% cut-off points to define the extreme market movements.
As such, an observation of daily or monthly market return is considered as an extreme
movement if it lies in the first, fifth and tenth lower or upper percentile of the market return
distribution.
CH approach suffers from a few drawbacks. First, the model captures herding under the
conditions of extreme returns only. Second, the definition of the extreme market movements
is arbitrary; investors may differ in their opinion as to what constitutes an extreme return
and the characteristics of the return distribution may change over time. Third, herding
behavior may occur to some extent over the entire return distribution, but become more
pronounced during periods of market stress (Tan et al., 2008). An alternative to this model is
the test of CCK. The herding test of CCK detects herding over the entire distribution of the
market return with the help of the following specification:
CSAD t 1 | R m,t | 2 R 2m,t e t

...(4)

where CSADt is a measure of return dispersion, which is measured by cross-sectional absolute


deviation:
CSAD t

1
N

| R i , t R m ,t |

...(5)

i 1

where Ri,t is the return of the security i at time t and Rm,t is the return of the market portfolio.
It should be noted that both |Rm,t| absolute value of the market return at time t and its
squared term R 2m ,t are included as independent variables in Equation (4).
CCK concluded that a rational pricing model predicts a linear relationship between the
market volatility and return dispersion under normal market conditions. It means that with
an increase in the market return, the dispersion of the individual stock returns will also
increase. Thus, a positive and statistically significant coefficient of 1 in Equation (4) will be
in line with the prediction of rational asset pricing model. However, the relation between
CSAD and market return becomes nonlinear during periods of relatively large price changes,
in which market participants do herding. In order to find out the nonlinear relationship, a
nonlinear market return variable R 2m ,t is included in the test equation. Thus, a negative
value of Equation (4) states the occurrence of herding behavior, as it reflects a negative,
nonlinear relationship between return dispersion and R 2m ,t during extreme stress.
It is advisable in herding literature to determine the effect of positive and negative market
returns separately, as it facilitates an examination of the extent of herding behavior in rising
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The IUP Journal of Applied Finance, Vol. 20, No. 2, 2014

and declining market. In order to check these asymmetric effects in herding behavior, the
following equations are used:

CSAD UP
1
t

UP

| R m,t

CSAD tDOWN 1

UP

DOWN

UP

| 2 R m2 ,t

| R m ,t

DOWN

UP

...(6)

e t , R m ,t 0

| 2

DOWN

R m2 ,t

DOWN

e t , R m ,t 0

where R m ,t UP is the market return at time t when the market rises; R m2 ,t

UP

...(7)

is the quadratic

term of the previous one; and is the CSAD at time t corresponding to R m ,t UP . Similar symbols
with superscript DOWN are used respectively in the case of market decline. In addition, the
absolute value of R m ,t UP and R m,t DOWN are used to facilitate the comparison of the linear
term coefficient in Equations (6) and (7). The market is considered to be rising when its
return is larger than zero; otherwise it is regarded as falling.
As herding behavior is believed to more likely exist in extreme market conditions due to
psychological reasons, to check the herding behavior in extreme high and low market
conditions using CCK model, the following equations are used on daily dataset with the
following specifications:
UP

2
CSAD UP
1UP | R m,t UP |*D U
t 2 R m ,t
t

CSAD tDOWN 1

DOWN

| R m ,t

DOWN

UP

* DU
t e t , R m ,t 0

|*D tL 2

DOWN

R m2 ,t

DOWN

...(8)

* D tL e t , R m ,t 0 ...(9)

, if the market return on day t lies in the extreme upper tail of the distribution
where D U
t 1
and equal to zero otherwise, and D tL 1, if the market return on day t lies on the extreme
lower tail of the distribution and is equal to zero otherwise. To decide about the upper tail and
lower tail, again 1%, 5% and 10% criteria are used.
To check the robustness of the results produced by the above-stated models and to
determine the impact of global financial crisis on herd behavior, CCK model is applied on
three sub-sample periods data: before the global financial crisis (April 2000 December
2007), during the global financial crisis (January 2008 December 2009) and after the global
financial crisis (January 2010 February 2012).
In addition, to check the stationarity of the time series, Augmented Dickey-Fuller (ADF)
test with a null hypothesis of unit root is applied. Some residual tests such as Jarque-Bera test,
Durbin-Watson test and ARCH LM test are also conducted to check the normality,
autocorrelation and heteroskedasticity of the error terms, respectively. As the presence of
the above-stated problems contradict the validity of the regression model, to solve the
Herding Behavior in an Emerging Stock Market: Empirical Evidence from India

23

problem of the non-normality, variable transformation and methods based on non-normality


assumptions are used. To avoid the problem of autocorrelation, lagged dependent variable is
added in some of the equations. To modify the standard error in the case of the presence of
heteroskedasticity, GARCH(1,1) model is used. In case of absence of continuous data, to
modify the standard error to curb the presence of heteroskedasticity and autocorrelation, the
Newey and West consistent estimator is determined, as autoregressive model and GARCH
model are both applicable only on continuous data series.

Data
The present study focuses on testing for herding in the Indian market with reference to its
main index S&P CNX Nifty 50. Nifty 50 is an index of National Stock Exchange (NSE) and
is used as a representative of the Indian stock market, as India does not have an all-share
index. Moreover, it is a well-diversified 50 stocks index, covering 22 sectors of the Indian
economy. NSE is selected in the study as it is the largest stock exchange in the country in
terms of daily turnover and trading.
Often, herding behavior is assumed to be a short-lived phenomenon. In order to check
herding in the short run in the Indian market, the daily stock prices of 50 stocks that are
listed on Nifty 50 and their index value from April 2000 to February 2012 are obtained from
Prowess database maintained by the Centre for Monitoring Indian Economy (CMIE).
However, the daily data restricts the ability to specify the herd behavior during periods of
market stress (Christie and Huang, 1995). Therefore, the monthly data of the same companies
and index for the same time period are also taken into consideration to check the herds
repulse during longer time horizons. The rationale behind choosing the sample period from
April 2000 is the inception of online trading in India in the year of 2000. Moreover, a
significant number of companies came into existence in the same year and provided the
Indian investor with online trading services. Therefore, the present study focuses on the
time frame during which the Indian investors were exposed to the online trading mechanism.
The daily and monthly price datasets are transformed to a time series of continuously
compounded returns by using the following formula:

ri,t Log(Pt |Pt 1 ) * 100

...(10)

where Pt and Pt1 are the prices of stock i at times t and t1.
Market return is also calculated in the same way. There are 2,969 daily observations and
143 monthly observations of index and stock returns.

Descriptive Statistics
Table 1 provides the descriptive statistics on daily and monthly market returns (Rm,t), crosssectional standard deviation (CSSDt) and cross-sectional absolute deviation (CSADt) for
the Indian stock market. The daily average returns of the Indian stock market over the entire
sample period is 0.0430% which fluctuates between 13.0539% and 16.3343%, while monthly
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The IUP Journal of Applied Finance, Vol. 20, No. 2, 2014

Table 1: Descriptive Statistics of the Daily and Monthly Data


(April 2000 February 2012)
Statistics

Daily Data
CSSD

CSAD

Monthly Data
Rm,t

CSSD

CSAD

Rm,t

Mean

2.4089

1.6538

0.0430

2.2574

2.2635

0.4157

Median

1.9520

1.4791

0.1244

2.0949

1.9883

0.5400

Maximum

41.9711

9.2197

16.3343

6.2426

7.9910

6.9900

Minimum

0.5463

0.3849

13.0539

1.1170

1.0014

4.2000

SD

2.5420

0.7329

1.6725

0.8791

1.0001

1.5912

Skewness

8.9202

2.9335

0.2822

2.1057

2.1298

0.0219

101.7129

19.1438

10.5200

8.9049

10.1844

5.3790

1244816.00

36499.30

7035.14

313.43

415.65

33.73

0.0000

0.0000

0.0000

0.0000

0.0000

0.0000

8.2377*

35.2114*

50.1917*

10.4442*

10.0243*

14.0105*

Kurtosis
Jarque-Bera
Probability
ADF Statistics

Note: * indicates significance at 1% level; and ADF indicates Augmented Dickey-Fuller Test Statistics.

average return is 0.42% which varies within the range of 4.2% and 6.99%. The equity
market return in the Indian stock market exhibits a high magnitude of volatility with a daily
standard deviation of 1.67% and monthly standard deviation of 1.59%.
Table 1 also specifies the univariate statistics on CSSD and CSAD measures. By definition,
when all the returns move in tandem with stock market, CSAD and CSSD are bound to be
low to zero and when the individual returns deviate from the stock market return, the CSAD
and CSSD levels increase. The daily average values of CSSD and CSAD are 2.41% and 1.65%,
respectively, which indicate the high deviation of individual return from market return.
Consistent with the results of Tan et al. (2008), the degree of dispersion measure increases
with the return interval. The average CSSD and CSAD based on the monthly data are greater
as the value of both is 2.26%. The difference reflects the fact that with monthly data, individual
returns have a greater opportunity to stay farther from mean (CH). Furthermore, the
significant probabilities of the Jarque-Bera test indicate that the residual distribution of the
market return and its dispersion are non-normal. The values of skewness and kurtosis mean
that the distribution of these variables has a leptokurtic feature. This implies that the
subsequent test of OLS should take into account this violation of the normality assumption.
To check the stationarity of the various series, ADF at level with intercept is used. The
significant t-statistics of this series confirms the rejection of the null hypothesis (H0: Series
follows a unit root) and ensures that the series is stationary at level and fit for the OLS.

Empirical Results
The analysis begins with the investigation of the presence of herd behavior in the Indian
stock market by employing the dummy variable regression test suggested by CH. The
coefficients of the dummy variables measure the herd behavior in extreme upward and
Herding Behavior in an Emerging Stock Market: Empirical Evidence from India

25

Table 2: Regression Results for CSSDt (CH Model)


(CSSDt = + 1DtL + 2DtU + et)
Daily

A
t-statistics

Monthly

1%
Criterion

5%
Criterion

10%
Criterion

1%
Criterion

5%
Criterion

10%
Criterion

2.3593*

2.2974*

2.2450*

2.1977*

2.1526*

2.0865*

50.5138

47.1350

43.4079

27.5027

26.0883

25.2572

2.6317*

1.3061*

0.9377*

0.3765

0.3379

0.3446

t-Statistics

5.6928

6.1378

6.0343

0.5129

1.0745

1.6218

2.2806*

0.9318*

0.7039*

3.7775*

1.4263*

1.1059*

t-Statistics

4.9333

4.3787

4.4537

5.1327

4.6082

5.3387

AR(1)

0.2104*

0.2047*

t-Statistics

2.7121

0.0104

2.4401

Adjusted R2

0.0179

0.0172

0.0164

0.1918

0.1661

0.2062

28.0889*

27.0875*

25.7791*

12.1505*

10.3606*

13.2069*

0.1748

0.1445

0.1521

0.1210

0.4413

0.1898

0.1749

0.1447

0.1522

0.1226

0.4462

0.1923

1.9538

1.9634

2.0000

2.2109

2.1564

2.1504

F-Statistic

0.1914*

Residual tests
ARCH Test
F-Value
Obs*R

Durbin-Watson
Stat.

Note: * indicates significance at 1% level.

downward price movement. Equation (3) is estimated using three criteria to define the extreme
market movement: The 1%, 5% and 10% criteria restrict DLt and DUt to 1%, 5%, and 10% of
the lower tail and 1%, 5% and 10% of the upper tail of the market return distribution. These
three criteria are adopted because the definition of an extreme market return is arbitrary. In
Table 2, the parameter estimates along with residual test statistics, F-values produced by
ARCH LM test and Durbin-Watson statistics are reported. The values of F and DurbinWatson statistics in the case of all six models indicate that the data is free from
heteroskedasticity and autocorrelation, and therefore, the results produced by these models
are valid.
The findings of the present study for the Indian market are consistent with the results of
CH. The positive and statistically significant 1 and 2 coefficients across all the three models
based on the daily data indicate that equity return dispersions actually tend to increase
rather than decrease during market environment characterized by extreme market
movements. This is inconsistent with their definition of herding which requires a decrease
in CSSD. On the other hand, other three models based on the monthly datasets more or less
produce the same kind of results, as the values of 1 and 2 coefficients are positive. However,
in the case of the monthly data, values of 1 coefficients are not statistically significant but
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The IUP Journal of Applied Finance, Vol. 20, No. 2, 2014

still are all positive, which also indicates the absence of herding in the Indian stock market.
Under both the datasets, the coefficient estimates produced by 1% criteria are higher than
the estimates produced by 5% and 10% criteria. In the same way, estimates of 5% criteria are
higher than 10% criteria estimates. Therefore, the predictions of rational asset pricing model
are most apparent when extreme market movements to the upper and lower percent of the
market return are small.
In order to overcome the limitations of CSSD specified by the various researchers and to
check the robustness of the results of CH model, CCK test is also applied. Table 3 provides
the results of empirical specification given by CCK. Equation (4) is estimated separately for
the daily and monthly datasets using the whole sample period. A significant coefficient of
the market return (1) indicates a linear relationship between stock market returns and their
dispersion which is also specified by rational asset pricing models. A positive and significant
Table 3: Results of CCK Model
2
(CSAD t 1 | R m,t | 2 R m,
t et )
Daily

Daily

1.3227*

1.5322*

Monthly

Monthly

1.5336*

1.5007*

Mean Equation
A
t-statistics
1

67.2949

t-Statistics
2

15.7957

t-Statistics

0.6743

AR(1)

t-Statistics

0.2768*
0.0016

72.5523
0.0865*
10.0797
0.0117*
17.2619
0.6465*
58.1422

15.9125

17.0511

0.4468*

0.4584*

4.1387

4.6466

0.0664*

0.0659*

3.0994

3.377

0.0069

0.0891

Conditional Variance Equation


RESID(1)^2

t-Statistics

GARCH (1)

t-Statistics

Adjusted R2

0.2146
406.6773*

F-Statistic

0.4715*
31.5299

0.2206

0.6849

0.7253

132.9124*

152.2046*

125.0932*

0.2793*
25.3138

Residual Test
ARCH Test
F-Value

4.4009*

0.0017

0.3274

0.3278

Obs.*R

4.3973*

0.0017

0.3309

0.3317

1.4842

2.778

1.5249

2.1898

Durbin-Watson Stat.

Note: * indicates significance at 1% level.


Herding Behavior in an Emerging Stock Market: Empirical Evidence from India

27

coefficient of the square term of the market return (2) means that herding behavior does not
seem to be present in the Indian stock market. In other words, herding is not observed in the
Indian stock market. The same thing can be concluded by reviewing Figures 1 and 2. This
finding implies that participants in this market make investment decision rationally. The R2
values of both the models based on daily and monthly data are 22.06% and 72.53%, respectively,
which indicate that a large proportion of CSAD can be explained by market return and their
square term.
Figure 1: CSAD vis--vis Daily Nifty Return from April 2000 to February 2012

NSE Return/CSAD

20
15
10
5
0
5
10
15

2000

2002

2004

2007

S&P CNX NIFTY Return

2009
CSAD

CSAD Nifty Return

Figure 2: CSAD vis--vis Monthly Nifty Return from April 2000 to February 2012
10
8
6
4
2
0
2
4
6

2
Months
1 CSAD

2 Market Return

In addition to the regression results, residual tests are also reported in Table 3. Indeed,
daily and monthly data based regression models exhibit the problems of autocorrelation as
the Durbin-Watson statistic is low. To curb the same problem, AR(1) term is added to both
the models. Higher orders have not improved the results and that is why the study has been
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The IUP Journal of Applied Finance, Vol. 20, No. 2, 2014

confined to AR(1). In addition, heteroskedasticity is also reported in the error term of the
return dispersion of the daily data, and to address the same, variance equation of that model
is also explained, which is following GARCH(1,1) model. The model produced a significant
value of GARCH factor which indicates the volatility clustering in the Indian market. The
results pertaining to the herding remained same as both the coefficients (1) and (2) are still
positive.
However, herding is not reported in the Indian stock market over the entire sample
period, but the finding can vary with the market conditions. In order to investigate herding
under different market conditions, regression models for up and down market price movement
are run separately. Table 4 reports the results of Equation (6) which is a test for herding in
rising market. The negative coefficients of square terms of the daily market return in the first
column imply the presence of mild herding in the Indian stock market, but it is not statistically
significant. The residual tests for the daily data regression show the presence of
heteroskedasticity and autocorrelation in the error term of return dispersion. As GARCH
and AR(1) model require a continuous sample, the equation could not be re-estimated by
using the same as the sample has split into rising and declining markets. To control
heteroskedasticity and autocorrelation, the Newey and West procedure is introduced.
Adjusted model run on the daily data and monthly data produced the same results which
Table 4: Up Market Regression Results (CCK Model)

(CSAD tUP 1

UP

| R m,t

Daily
(1,605 Observations)

UP

2
| 2UP R m,
t

UP

e t , R m,t 0)

Daily (with Newey-West)


(1,605 Observations)

Monthly
(94 Observations)

Mean Equation
A

1.3383*

t-Statistics

48.5479

0.2831*

1.3383*
39.8431

1.4994*
16.6939

0.2831*

0.6503*

t-Statistics

11.5414

7.8383

6.8568

0.0031

0.0031

0.0437*

t-Statistics

0.9346

0.4852

2.5219

0.1591

0.1591

0.8353

152.7559

152.7559

236.6888

F-Value

0.7618

0.7618

1.1655

Obs*R

0.7624

0.7624

1.176

Durbin-Watson Stat.

1.4502

1.4502

2.008

Adjusted R2
F-Statistic
Residual Test
ARCH Test

Note: * indicates significance at 1% level.


Herding Behavior in an Emerging Stock Market: Empirical Evidence from India

29

indicate the absence of herding in the Indian market, as in case of daily data 2 is negative but
not statistically significant, and on the other hand, in monthly data analysis, 2 is significantly
positive.
The same procedure is also employed on the declining market data using Equation (7) and
the results of the same are presented in Table 5. The data is not continuous here and therefore
the Newey-West procedure is used to avoid the problem of heteroskedasticity and
autocorrelation exhibited in the daily data regression. The results of the daily and monthly
data again indicate the absence of herding in declining market too, as the 2 in both models
is positive and not significant.
Table 5: Down Market Regression Results (CCK Model)

(CSAD tDOWN 1

DOWN

| R m,t

DOWN

Daily
(1,364 Observations)

| 2

DOWN

2
| R m,
t

DOWN

Daily (with Newey-West)


(1,364 Observations)

e t , R m,t 0)
Monthly
(49 Observations)

Mean Equation
A

1.3126*

t-Statistics

46.8534

0.2583*

1.3126*
33.2443

1.5888*
7.8967

0.2583*

0.0031

5.9508

0.0109

0.0079**

0.0079

0.1337

2.2148

1.065

1.8824

0.2828

0.2828

0.4659

269.7187

269.7187

21.9396

F-Value

3.3177

3.3177

0.0092

Obs*R2

3.3145

3.3145

0.0096

1.4923

1.4923

2.4404

t-Statistics

10.2616

2
t-Statistics
Adjusted R

F-Statistic
Residual Test
ARCH Test

Durbin-Watson Stat.

Note: * and ** indicate significance at 1% and 5% levels, respectively.

In order to check herding using CCK model in extreme market conditions, regression
models are run using Equations (8) and (9). The results of the same are presented in Table 6
which reconfirm the findings of CH model. Table 6 shows the absence of herding in Indian
market in extreme market conditions too as values of 2 in the case of all regression models
are positive.
Herding behavior is found to be more prevalent during uncertain market conditions. It
can also be seen during the global financial crisis. The negative impact of the global financial
30

The IUP Journal of Applied Finance, Vol. 20, No. 2, 2014

Table 6: Regression Results for CCK


Model in Extreme Market Conditions

(CSAD tDOWN 1

DOWN

CSAD tUP 1

| R m,t

UP

DOWN

| R m,t

UP

|*D tL 2

|*D tU 2

UP

DOWN
2
R m,
t

2
R m,
t

UP

DOWN

* DU
t e t , R m,t 0)

Down
1%

5%

* D tL e t , R m,t 0

Up
10%

1%

5%

10%

Mean Equation
A

1.6498*

1.6266*

1.6163*

1.6604*

1.6507*

1.6469*

t-Statistics

66.8047

84.0326

85.138

73.1741

75.1947

75.4928

0.1571*

0.0284*

0.0162*

0.0079

0.0271*

0.0288*

t-Statistics

6.2049

3.7091

2.1379

0.6355

2.6349

3.1183

0.0389*

0.0213*

0.0236*

0.0127*

0.0116*

0.0120*

t-Statistics

11.4154

18.3172

20.7488

13.0414

13.6671

15.6608

AR(1)

0.6756*

0.6575*

0.6521*

0.6953*

0.6876*

0.6908*

t-Statistics

58.7244

25.1529

57.2326

61.7972

61.3926

62.4756

Conditional Variance Equation


RESID (1)^2

0.4909*

0.5362*

0.5237*

0.5316*

0.5171*

0.5302*

t-Statistics

46.4456

31.8771

31.5661

33.307

33.185

33.7414

GARCH (1)

0.4909*

0.2879*

0.2846*

0.2432*

0.2539*

0.2412*

t-Statistics

30.9121

25.9339

25.4342

23.4107

23.9759

23.37559

0.1658

0.1839

0.1882

0.1582

0.1678

0.1681

F-Value

0.0036

0.0290

0.0254

0.0013

0.0006

0.0013

Obs*R2

0.0036

0.0290

0.0254

0.0013

0.0006

0.0013

Durbin-Watson
Stat.

2.3506

2.3596

2.3512

2.3632

2.3603

2.3652

Adjusted R2
Residual Test
ARCH Test

crisis reduced investors confidence level in stock markets and made the market highly volatile
in 2008-09. So in order to check the herding behavior during the global financial crisis, the
daily dataset was divided into three sub-samples (before the crisis, during the crisis and after
the crisis) and CCK model was applied on them. The results of the same are given in Table 7.
It is observed that herding behavior is found to be prevalent in the Indian stock market
during the crisis period as 2 regression coefficient value is negative and statistically significant,
which indicates that CSAD decreases with increase in market returns.
Herding Behavior in an Emerging Stock Market: Empirical Evidence from India

31

Table 7: Regression Results Using CCK


Model in Different Time Frames
2
(CSAD t 1 | R m,t | 2 R m,
t et )

Before the Crisis


(Apr. 2000
Dec. 2007)

During the Crisis


(Jan. 2008
Dec. 2009)

After the Crisis


(Jan. 2010
Feb. 2012)

Mean Equation

1.4604*

t-Statistics

69.4491

1.7227*
16.9624

1.1726*
20.3328

0.0652*

0.1107*

0.1163

t-Statistics

2.4378

3.6020

1.2339

0.0287

0.0044*

0.0129

t-Statistics

5.3475

2.2890

0.3508

AR(1)

0.4197

0.5789*

0.1804*

22.9065

8.2375

2.8899

0.3156*

0.0338*

2.9735

3.3063

0.0227

0.8786*

t-Statistics

Conditional Variance Equation


RESID(1)^2
t-Statistics

0.1509*
24.1701

GARCH (1)
t-Statistics

0.8010*
196.7253

0.2225

25.2156

0.2452

0.3428

0.0609

F-Value

0.1809

0.1369

0.0001

Obs.*R

0.1811

0.1379

0.0001

2.3786

2.1947

2.1444

Adjusted R2
Residual Test
ARCH Test
2

Durbin-Watson Stat.

Conclusion
Herding is recognized as a psychological phenomenon which is used in the financial world to
explain the scenarios in which investors irrationally follow each others decision. The presence
of herding indicates market inefficiency and abnormal market volatility. Considering the
growth of the Indian financial sector, international investors are giving more weight to
Indian market in their investment portfolio. However, the Indian market is believed to be
riskier and less mature than other developed world stock markets. Consequently, investigating
the herding behavior in this market may help develop new insights regarding the efficiency
as well as risk profile of the Indian market which may guide an investor to form a proper
investment strategy.
32

The IUP Journal of Applied Finance, Vol. 20, No. 2, 2014

This study tested the existence of market herding in India by using two methodologies:
one based on CSSD proposed by Christie and Huang (1995) and the other based on CSAD
developed by Chang et al. (2000). The study measured the herding behavior in Indian market
for a period extending from April 2000 to February 2012 and found that equity return
dispersions tend to increase during periods of extreme price movements which should rather
get decreased, thereby providing evidence against the presence of herding in the Indian stock
market. In other words, absence of herding validates the applicability of the rational pricing
models in the Indian stock market. People were found to exhibit herding behavior during
times of crisis, but they corrected their behavior once the market condition was set right. In
conclusion, the present study contributes to the existing literature on herding in emerging
markets. The findings of the study prove the strength of the Indian stock market in normal
time period, though existence of herding is found during periods of crisis.

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