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The Impact of Herding on Futures Prices
Abstract
We test the prevalence of herding among large speculative traders in futures markets by employing a unique dataset from the U.S. CFTC on individual positions of these traders in thirty-two futures markets covering 2002 -2006. Using detailed trader level data we test, for the first known time, whether herding exists among hedge funds and other speculative traders, and whether the herding serves to stabilize or destabilize market prices. While we find some mild evidence of herding among hedge funds and other types of speculators we conclude that the magnitude of herding by hedge funds is, on average, similar to that found in equity market studies and that this herding is not destabilizing.
... Derivatives markets have also been a topic of investigation regarding its nexus with herding phenomena. Academic work such as McAleer and Radalj (2013), Demirer et al. (2015), and Boyd et al. (2016) look into this interesting strand of academic work. To be more precise, McAleer and Radalj (2013) investigate futures positions in nine markets of the Commodity Futures Trading Commission (CFTC). ...
... It is also argued that the stock market does not exert effects on herding behaviour in the commodity futures market. Moreover, Boyd et al. (2016) examine whether herding exists among large speculative traders in thirty-two futures markets. Outcomes indicate the existence of herding in a modest level among hedge funds and floor brokers/traders. ...
This paper reviews the empirical literature on the highly popular phenomenon of herding behaviour in the markets of digital currencies. Furthermore, a comparison takes place with outcomes from earlier studies about traditional financial assets. Moreover, we empirically investigate herding behaviour of 240 cryptocurrencies during bull and bear markets. The present survey suggests that empirical findings about whether herding phenomena have made a significant appearance or not in cryptocurrency markets are split. The Cross-sectional absolute deviations (CSAD) and Cross-sectional standard deviations (CSSD) approaches for measuring herding tendencies are found to be the most popular. Different behaviour is detected in bull periods compared to bear markets. Nevertheless, evidence from primary studies indicates that herding is stronger during extreme situations rather than in normal conditions. However, our empirical estimations reveal that herding behaviour is evident only in bull markets. These findings cast light on and provide a roadmap for investment decisions with modern forms of liquidity.
... Hedge fund positions, however, significantly decrease the likelihood of remaining in the same regime, which is evidence that hedge funds largely serve to stabilize futures markets by positioning against oil market price trends (similar evidence is found in [15,61]). Importantly, the value of the log-likelihood is the highest for hedge funds, indicating that they bring relatively more information about price reversals than other traders do. ...
We analyze the role of hedge fund, swap dealer, and arbitrageur activity in the crude oil market. The contribution of our work is to examine the role of institutional traders in switching between high-volatility and low-volatility regimes. Using confidential position data on institutional investors, we first analyze the linkages between trader positions and fundamentals. We find that these institutional position changes reflect fundamental economic factors. Subsequently, we adopt a Markov regime-switching model with time-varying probabilities and find that institutional position changes contribute incrementally to the probability of regime changes.
... Numerous researchers have examined herding behavior in various markets using daily aggregated market data of individual investors. For instance, many studies investigated the herding in cryptocurrencies (Bouri et al., 2019a;Della Rossa et al., 2020;Yarovaya et al., 2021;Yousaf et al., 2021), commodity market (Júnior et al., 2020;Kumar et al., 2021;Youssef, 2020), financial markets (Batmunkh et al., 2020;Bowe & Domuta, 2004;Chang et al., 2000;Ukpong et al., 2021;Zhu et al., 2020), and futures market (Boyd et al., 2016;Gleason et al., 2003). However, the studies on the dynamic herd behavior and its non-linear macroeconomic drivers in North-American energy market are scant in the extant literature. ...
... Moreover, many researchers used the measure of Hwang and Salmon (Güvercı̇n, 2016;Krokida, Spyrou, & Tsouknidis, 2017;Lin, (2017) ;Teng, 2018). The measures of the second group, Lakonishoket al. (1992) and Sias (2004), were also used in many studies to measure herding behavior (Boyd, Buyuksahin, Haigh, & Harris, 2016;Cai, Han, Li, & Li, 2019;Choi, 2016;Fang, Lu, Yau, & Lee, 2017;Popescu & Xu, 2018). In addition, many studies were conducted using more than one measure including Shrotryia and Kalra (2019) who used three measures of CSSD, CSAD, and a modified CSSD measure introduced by Yao, Ma, and He (2014). ...
Herding behavior was concluded to exist in some sectors and under some market conditions in the Jordanian stock market when measured using the cross-sectional absolute deviation. The purpose of this study was to retest the existence of the sectoral herding using the cross-sectional dispersion of betas and compare the results with those reached using the measure of the cross-sectional absolute deviation. Behavioral finance theory represents the main base on which this study was built. In this study, the researcher tried to answer questions related to whether herding behavior exists in the Jordanian market and its sectors if measured using cross-sectional dispersion of betas and whether results will be different from those reached using other measures. In this quantitative study, data from Amman stock exchange were used and the period covered was from 2000 to 2018. These data were used to calculate the cross-sectional dispersion of betas which was tested using t-test, Kruskal–Wallis test, Mann-Whitney U test, and Wilcoxon Signed-Rank test. Results indicated that herding behavior existed in market and in each sector at the same level which was not affected by the financial crisis. Furthermore, the study revealed that herding level was the same when the market (sector) was rising and when it was falling and this similarity has not been changed by the occurrence of the global financial crisis. Finally, results indicated that herding was at its lowest level in the entire market and in the industrial sector during the time of financial crisis. These results are different from those of the study conducted in Jordan using cross-sectional absolute deviation which implies that using different herding measures yields different results.
This study employs state‐space models and the quantile‐on‐quantile regression technique to examine the dynamics of intentional and fundamental herding in North American energy stocks, together with its non‐linear determinants. Our findings reveal persistent herding in North American energy stocks, with no exceptions during the global financial crisis, COVID‐19, lockdown and post‐lockdown period, which is primarily driven by intentions. In all of these cases, herding is primarily motivated by intentional drivers rather than fundamental factors. Our results also show a herding asymmetry during bullish and bearish market conditions, but herding during bullish (bearish) market condition is mainly driven by the intentions (fundamentals). The findings of our quantile‐on‐quantile regression show that the effects of macroeconomic variables on time‐varying herding are, in fact, regime‐specific. We generally find evidence of herding (anti‐herding) at the lower (upper) quartiles of energy stocks liquidity, oil price shocks, economic policy uncertainty and oil market implied volatility. The investment community engaged in North American energy stocks can benefit from our study, as awareness about regime‐specific effects of various market variables on intentional (fundamental) herding can be a useful input in designing asset allocation and hedging strategies. The outcome of our study may provide interesting input to regulators to develop the dynamic legislative framework focusing on policies to encourage investment diversification during regime‐specific systemic risk escalation resulting from the dynamic behaviour of herding and macroeconomic variables.
This paper sets out to explore whether convergence and herding phenomena exist for digital currencies. Daily data cover a large spectrum of cryptocurrencies in separate bull and bear periods. Empirical estimations for detecting club convergence and clustering are performed by the methodology proposed by Phillips and Shu (2007, 2009). Econometric outcomes reveal preliminary evidence of powerful herding behaviour. The lowest of large-cap digital currencies attract mainly cryptocurrencies which are about in the middle of the large-cap and medium-cap categories whereas the highest-cap cryptocurrencies are parts of convergence clubs with mostly large-cap or purely medium-cap digital currencies during bear markets. Notably, segmentation is higher during bear markets as clusters are formed around more numerous cryptocurrencies than during bull markets. Convergence is stronger during flourishing periods.. Secondary herding is also realized among pairs of clubs. Our findings enable investors to better diversify their portfolios and ameliorate their risk-return trade-off during extreme events.
The coincident rise in crude oil prices and increased numbers of financial participants in the crude oil futures market from 2000-2008 has led to allegations that "speculators" drive crude oil prices. As crude oil futures peaked at $147/bbl in July 2008, the role of speculators came under heated debate. In this paper, we employ unique data from the U.S. Commodity Futures Trading Commission (CFTC) to test the relation between crude oil prices and the trading positions of various types of traders in the crude oil futures market. We employ Granger Causality tests to analyze lead and lag relations between price and position data at daily and multiple day intervals. We find little evidence that hedge funds and other non-commercial (speculator) position changes Granger-cause price changes;–the results instead suggest that price changes do precede their position changes.
The possibility that speculative trading destabilizes or creates a volatile market is frequently debated. To test the hypothesis that speculative trading is destabilizing we employ a unique dataset from the U.S. Commodity Futures Trading Commission (CFTC) on individual positions of speculators. While others have used a more aggregated version of our data, here we test, for the first known time, whether speculators cause, in a forecasting sense, price movements and volatility in futures markets and, therefore, destabilize markets. Our findings provide evidence that speculative trading in futures markets is not destabilizing. In particular, speculative trading activity reduces volatility levels.
This paper explores the impact of investor flows and financial market conditions on returns in crude oil futures markets. I argue that informational frictions and the associated speculative activity may induce prices to drift away from “fundamental” values, and may result in price booms and busts. Particular attention is given to the interplay between imperfect information about real economic activity, including supply, demand, and inventory accumulation, and speculative activity in oil markets. Furthermore, I present new evidence that there were economically and statistically significant effects of investor flows on futures prices, after controlling for returns in the United States and emerging-economy stock markets, a measure of the balance sheet flexibility of large financial institutions, open interest, the futures/spot basis, and lagged returns on oil futures. The largest impacts on futures prices were from intermediate-term growth rates of index positions and managed-money spread positions. Moreover, my findings suggest that these effects were through risk or informational channels distinct from changes in convenience yield. Finally, the evidence suggests that hedge fund trading in spread positions in futures impacted the shape of term structure of oil futures prices.
This paper was accepted by Wei Xiong, finance.
Hedge funds databases are typically subject to high attrition rates because of fund termination and self-selection. Even when all funds are included up to their last available return, one cannot prevent that ex post conditioning biases a.ect standard estimates of performance persistence. In this paper we analyze the persistence in the performance of U.S. hedge funds taking into account look-ahead bias (multi-period sampling bias). To do so, we model attrition of hedge funds and analyze how it depends upon historical performance. Next, we use a weighting procedure that eliminates look-ahead bias in measures for performance persistence. The results show that the impact of look-ahead bias is quite severe, even though positive and negative survival-related biases are sometimes suggested to cancel out. At horizons of one and four quarters, we find clear evidence of positive persistence in hedge fund returns, also after correcting for investment style. At the two-year horizon, past winning funds tend to perform poorly in the future.
This article explores the behavior of emerging market mutual funds using a novel database covering the holdings of individual funds over the period January 1996 to December 2000. The degree of herding among funds is statistically significant, but moderate. Herding is more widespread among open-ended funds than among closed-end funds, but not more prevalent during crises than during tranquil times. We find some evidence that funds tend to follow momentum strategies, selling past losers and buying past winners. [JEL F21, G15] E pisodes of high volatility in international capital flows and currency crises in the 1990s have put international investors in the limelight. Frequently, inter-national investors are seen as the culprits of the bouts of instability and crises, 1 and casual observation does suggest the presence of episodes of panic and contagion. Yet the fundamental question remains as to whether there is a tendency for certain market participants to disregard fundamental economic conditions in emerging 43
An informational cascade occurs when it is optimal for an individual, having observed the actions of those ahead of him, to follow the behavior of the preceding individual with regard to his own information. The authors argue that localized conformity of behavior and the fragility of mass behaviors can be explained by informational cascades. Copyright 1992 by University of Chicago Press.
Investment in professionally-managed, publicly-traded commodity funds has grown rapidly in recent years. This is the first comprehensive study of the performance of these funds. It is found that randomly selected funds offer neither an attractive alternative to bonds nor a profitable addition to a portfolio of stocks and bonds. Furthermore, past performance of these funds offers very little information about future performance. The findings may be explained by the large transactions costs incurred by these funds and their primary reliance on technical analysis. Copyright 1987 by the University of Chicago.
This paper explores how Bayes-rational individuals learn sequentially from the discrete actions of others. Unlike earlier informational herding papers, we admit heterogeneous preferences. Not only may type-specific "herds" eventually arise, but a new robust possibility emerges: confounded learning. Beliefs may converge to a limit point where history offers no decisive lessons for anyone, and each type's actions forever nontrivially split between two actions. To verify that our identified limit outcomes do arise, we exploit the Markov-martingale character of beliefs. Learning dynamics are stochastically stable near a fixed point in many Bayesian learning models like this one.
This study analyzes the extent to which mutual funds purchase stocks based on their past returns as well as their tendency to exhibit 'herding' behavior (i.e., buying and selling the same stocks at the same time). The authors find that 77 percent of the mutual funds were 'momentum investors,' buying stocks that were past winners; however, most did not systematically sell past losers. On average, funds that invested on momentum realized significantly better performance than other funds. The authors also find relatively weak evidence that funds tended to buy and sell the same stocks at the same time. Copyright 1995 by American Economic Association.
A major issue in recent years is the role that large, managed futures funds and pools play in futures markets. Many market participants argue that managed futures trading increases price volatility due to the size of managed futures trading and reliance on positive feedback trading systems. The purpose of this study is to provide new evidence on the impact of managed futures trading on futures price volatility. A unique data set on managed futures trading is analyzed for the period 1 December 1988 through 31 March 1989. The data set includes the daily trading volume of large commodity pools for 36 different futures markets. Regression results are unequivocal with respect to the impact of commodity pool trading on futures price volatility. For the 72 estimated regressions (two for each market), the coefficient on commodity pool trading volume is significantly different from zero in only four cases. These results constitute strong evidence that, at least for this sample period, commodity pool trading is not associated with increases in futures price volatility.
Changes in variance, or volatility, over time can be modeled using the approach based on autoregressive conditional heteroscedasticity. Another approach is to model variance as an unobserved stochastic process. Although it is not easy to obtain the exact likelihood function for such stochastic variance models, they tie in closely with developments in finance theory and have certain statistical attractions. This article sets up a multivariate model, discusses its statistical treatment, and shows how it can be modified to capture common movements in volatility in a very natural way. The model is then fitted to daily observations on exchange rates.
The authors test the performance of a number of global hedge funds over a four–year period in order to determine whether they could have been responsible for the crash in the Asian currencies in 1997. They use Sharpe's style analysis to measure the variations in the historical exposure of these funds to Asian currencies leading up to the crisis. The results indicate that fund profits were not generally positive during the crisis, nor were funds' estimated exposures to Asian currencies unusual. Consequently, the authors find no empirical evidence to support the hypothesis that George Soros, or any other hedge fund manager, was responsible for the crisis. Style analysis suggests that global managers actively vary their exposures to currencies, but over the period 1993 through 1997 these fluctuations were not found to be associated with moves in exchange rates.
The purpose of this article is to characterize linear and nonlinear serial dependence in daily futures price changes. The daily prices of four futures are included in this study: (i) S&P 500; (ii) Japanese yen; (iii) Deutsche mark; and (iv) Eurodollar. Our major empirical findings are: (i) Based on the results of nonlinearity tests (that is, the BDS, the Q2, and the TAR-F tests), we found all futures price changes contain nonlinearity in the series; (ii) a GARCH model can explain the source of nonlinearity for three out of four series; (iii) a threshold autoregressive model and autoregressive volatility model can adequately represent nonlinear dynamics of S&P 500 series; and (iv) deterministic chaos is not evident in the scaled residuals from the nonlinear time series models. Hence we favor a statistical time series approach to represent the data-generating mechanism of futures price changes. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 325–351, 1999
Policymakers often express concern that herding by financial market participants destabilizes markets and increases the fragility of the financial system. This paper provides an overview of the recent theoretical and empirical research on herd behavior in financial markets. It addresses the following questions: What precisely do we mean by herding? What could be the causes of herd behavior? What success have existing studies had in identifying such behavior? And what effect does herding have on financial markets?
This paper investigates the effect of fund managers' performance evaluation on their asset allocation decisions. We derive optimal contracts for delegated portfolio management and show that they always contain relative performance elements. We then show that this biases fund managers to deviate from return-maximising portfolio allocations and follow those of their benchmark (herding). In many cases the trustees of the fund who employ the fund manager prefer such a policy. We also show that fund managers in some situations ignore their own superior information and "go with the flow" in order to reduce deviations from their benchmark. We conclude that incentive provisions for portfolio managers are an important factor in their asset allocation decisions.
--Investments in Asian bonds rather than Asian equities. We find no correlation with the J. P. Morgan Brady bond index or the J. P. Morgan emerging-market local bond index beyond the correlation with the ING/Barings index.
Adams, Charles, Donald J. Mathieson, Garry Schinasi, and Bankim Chadha. 1998. International Capital Markets: Developments, Prospects, and Key Policy Issues. World Economic and Financial Surveys. Washington: International Monetary Fund.
Basel Committee on Bank Supervision. 1999a. Banks' Interactions with Highly Leveraged Institutions. Publication 45. Basel: Bank for International Settlements.
Eichengreen, Barry, Donald Mathieson, Bankim Chadha, Anne Jansen, Laura Kodres, and Sunil Sharma. 1998. Hedge Fund and Financial Market Dynamics. Occasional Paper 166. Washington: International Monetary Fund (May 15).
A major issue in recent years is the role that large, managed futures funds and pools play in futures markets. Many market participants argue that managed futures trading increases price volatility due to the size of managed futures trading and reliance on positive feedback trading systems. The purpose of this study is to provide new evidence on the impact of managed futures trading on futures price volatility. A unique data set on managed futures trading is analyzed for the period 1 December 1988 through 31 March 1989. The data set includes the daily trading volume of large commodity pools for 36 different futures markets. Regression results are unequivocal with respect to the impact of commodity pool trading on futures price volatility. For the 72 estimated regressions (two for each market), the coefficient on commodity pool trading volume is significantly different from zero in only four cases. These results constitute strong evidence that, at least for this sample period, commodity pool trading is not associated with increases in futures price volatility. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 759–776, 1999
Previous empirical studies of information cascades use either naturally occurring data or laboratory experiments. We combine attractive elements from each of these lines of research by observing market professionals from the Chicago Board of Trade (CBOT) in a controlled environment. Analysis of over 1,500 individual decisions suggests that CBOT professionals behave differently from our student control group. For instance, professionals are better able to discern the quality of public signals and their decisions are not affected by the domain of earnings. These results have implications for market efficiency and are important in both a positive and normative sense.
Relative to onshore funds, offshore funds are subject to less taxes and regulation. So they may trade more aggressively and do so in ways that could destabilize the emerging markets. We study the behavior of the offshore funds in Korea and compare them with the onshore funds. Evidence suggests that they do trade more frequently. However, they do not engage in momentum trading. In contrast, many onshore funds do. Finally, while they engage in herding, the onshore funds do it even more during a crisis. Therefore, it is inappropriate to single out the offshore funds as being especially worrisome.
We examine the risk characteristics and capital adequacy of hedge funds through the Value-at-Risk approach. Using extensive data on nearly 1,500 hedge funds, we find only 3.7% live and 10.9% dead funds are undercapitalized as of March 2003. Moreover, the undercapitalized funds are relatively small and constitute a tiny fraction of total fund assets in our sample. Cross-sectionally, the variability in fund capitalization is related to size, investment style, age, and management fee. Hedge fund risk and capitalization also display significant time variation. Traditional risk measures like standard deviation or leverage ratios fail to detect these trends.
We analyze the dynamics of the S&P 500 futures price, finding both short- and long-run effects of order flow on price. While price moves strongly with the order flow in the short-run, the long-run impact is slightly negative, attributable to costly slippage from a hedging propensity in futures markets. We find strong evidence of a state dependence in the relation between price and order flow, using both volume and floor trader income measures as states. We also find that both the long- and short-run impacts of order flow are greater when dealer income is higher.
We investigate the claim that hedge funds offer investors a superior risk-return tradeoff. We do so using a continuous-time version of Dybvig's (1988a), (1988b) payoff distribution pricing model. The evaluation model, which does not require any assumptions with regard to the return distribution of the funds to be evaluated, is applied to the monthly returns of 77 hedge funds and 13 hedge fund indices from May 1990-April 2000. The results show that, as a stand-alone investment, hedge funds do not offer a superior risk-return profile. We find 12 indices and 72 individual funds to be inefficient, with the average efficiency loss amounting to 2.76% per annum for indices and 6.42% for individual funds. Part of the inefficiency cost of individual funds can be diversified away. Funds of funds, however, are not the preferred vehicle for this as their performance appears to suffer badly from their double fee structure. Looking at hedge funds in a portfolio context results in a marked improvement in the evaluation outcomes. Seven of the 12 hedge fund indices and 58 of the 72 individual funds classified as inefficient on a stand-alone basis are capable of producing an efficient payoff profile when mixed with the S&P 500. The best results are obtained when 10%-20% of the portfolio value is invested in hedge funds.
This paper investigates the returns on British collectible postage stamps over the very long run, based on stamp catalogue prices. Between 1900 and 2008, we find an annualized return on stamps of 6.7% in nominal terms, which is equivalent to an average real return of 2.7% per annum. Prices have increased much faster in the second half of the 1960s, the late 1970s, and the current decade. However, we also record prolonged periods of real depreciation, for example in the 1980s. As a financial investment, stamps have outperformed bonds, but underperformed stocks. After unsmoothing the returns on stamps, we find that the volatility of stamp prices approaches that of equities. There is mixed evidence that stamps are a good hedge against inflation. Once the problem of non-synchronous trading is taken into account, stamp returns seem impacted by movements in the equity market.
This paper examines individual decision making when decisions reflect on people's ability to learn. The authors address this problem in the context of a manager making investment decisions on a project over time. They show that, in an effort to appear as a fast learner, the manager will exaggerate his own information but ultimately he becomes too conservative, being unwilling to change his investments on the basis of new information. The authors' results arise purely from learning about competence rather than concavity or convexity of the rewards functions. They relate their results to the existing psychology literature concerning cognitive dissonance reduction. Copyright 1996 by University of Chicago Press.
This paper demonstrates that, in a simple setting with managerial concern for reputation and asymmetric information on ability, most managers may refrain from undertaking innovations that stochastically dominate an industry standard. Common components of uncertainty lead to market inferences of managerial ability based on relative performance. Managers who undertake the industry standard are consequently evaluated with a more accurate benchmark than those innovating. Discontinuities in compensation when performance is low lead managers to have differing valuations of an accurate benchmark, depending on type. In particular, very high and very low ability managers are more likely to undertake superior innovations than those of average ability. Copyright 1995 by University of Chicago Press.
Dividing the 223 largest traders of heating oil futures between June 1993 and March 1997 into 11 different line-of-business groupings, we document their trading activity. We find substantial and significant differences between the 11 trader types in their propensity to take long, short, or spread positions; the terms-to-maturity of their holdings; their turnover rates; and the size of their positions. We also find that both trading volume and open-interest positions are dominated by potential hedgers but that it is not appropriate to treat traders whom the Commodity Futures Trading Commission classifies as commercials as hedgers.
We consider trading costs in the transparent, competitive open outcry markets of the Chicago Mercantile Exchange (CME), in which market makers have no affirmative obligation to trade. We document that while CME spreads are similar in magnitude to those in other markets, realized spreads are often negative. A plausible explanation is that CME market makers are able to employ more complex trading strategies than their equity market counterparts because they are not bound by affirmative obligation. The evidence suggests that market transparency and market maker obligations are important determinants of intraday variation in trading costs. Copyright 2001 by University of Chicago Press.
The authors examine the performance of the off-shore hedge fund industry over the period 1989 through 1995 using a database that includes both defunct and currently operating funds. The industry is characterized by high attrition rates of funds, low covariance with the U.S. stock market, evidence consistent with positive risk-adjusted returns over the time, and little evidence of differential manager skill. Copyright 1999 by University of Chicago Press.
Statistical techniques are used to demonstrate that the fortunes of individual futures traders are determined by luck, not forecast ability. Even though a large number of traders appear to exhibit significantly superior forecast ability, the investigation strongly supports three conclusions: there are fewer participants with significantly superior skill than expected if participants trade randomly, there are more traders exhibiting no skill than expected if participants trade randomly, and forecast ability is not correlated over time--superior forecasters in the early period are only average forecasters in the later period. Therefore it is luck that determines trader performance. Copyright 1991 by University of Chicago Press.
The author analyzes a sequential decision model in which each decisionmaker looks at the decisions made by previous decisionmakers in taking her own decision. This is rational for her because these other decisionmakers may have some information that is important for her. The author then shows that the decision rules that are chosen by optimizing individuals will be characterized by herd behavior; i.e., people will be doing what others are doing rather than using their information. The author then shows that the resulting equilibrium is inefficient. Copyright 1992, the President and Fellows of Harvard College and the Massachusetts Institute of Technology.
We examine the performance of the off-shore hedge fund industry over the period 1989 through 1995 using a database that includes both defunct and currently operating funds. The industry is characterized by high attrition rates of funds, low covariance with the U.S. stock market, evidence consistent with positive risk-adjusted returns over the time, and little evidence of differential manager skill.
We use futures transaction data to investigate cross-sectional relationships between market-maker inventory positions and
trade activity. The investigation documents strongly that traders control inventory throughout the trading day. Despite this
evidence of inventory management, typical inventory control models are contradicted by our data. These inventory models predict
that market-maker reservation prices are negatively influenced by inventory. Surprisingly, our evidence shows, as a strong
and consistent empirical regularity, that correlations between inventory and reservation prices are positive. We interpret
the evidence as consistent with active position taking by futures market floor traders.
The use of analyst forecasts as proxies for investors' earnings expectations is commonplace in empirical research. An implicit assumption behind their use is that they reflect analysts' private information in an unbiased manner. As demonstrated here, this assumption is not necessarily valid. There is shown to be a tendency for analysts to release forecasts closer to prior earnings expectations than is appropriate, given their information. Further, analysts exhibit herding behavior, whereby they release forecasts similar to those previously announced by other analysts, even when this is not justified by their information. These results are shown to have interesting empirical implications. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
This article characterizes the systematic risk exposures of hedge funds using buy-and-hold and option-based strategies. Our
results show that a large number of equity-oriented hedge fund strategies exhibit payoffs resembling a short position in a
put option on the market index and therefore bear significant left-tail risk, risk that is ignored by the commonly used mean-variance
framework. Using a mean-conditional value-at-risk framework, we demonstrate the extent to which the mean-variance framework
underestimates the tail risk. Finally, working with the systematic risk exposures of hedge funds, we show that their recent
performance appears significantly better than their long-run performance.
Analyses of rational speculation usually presume that it dampens fluctuations caused by "noise" traders. This is not necessarily the case if noise traders follow positive-feedback strategies--buy when prices rise and sell when prices fall. It may pay to jump on the bandwagon and purchase ahead of noise demand. If rational speculators' early buying triggers positive-feedback trading, then an increase in the number of forward-looking speculators can increase volatility about fundamentals. This model is consistent with a number of empirical observations about the correlation of asset returns, the overreaction of prices to news, price bubbles, and expectations.
This article contributes to the debate on hedge funds and exchange rates in Thailand and Malaysia. It provides the first empirical evidence on causal relation between hedge funds and exchange rates. Using a new Granger noncausality procedure proposed by Toda and Yamamoto (1995) and monthly data for the January 1994 to April 2002 period, two important findings emerge. First, hedge funds lead Thai baht during the 1997 crisis. Second, there is a bidirectional causality between hedge funds and Malaysian ringgit for the pre-crisis period. In all other cases, no causal relation can be established.
This article contributes to the debate on hedge funds and exchange rates in Thailand and Malaysia. It provides the first empirical evidence on causal relation between hedge funds and exchange rates. Using a new Granger noncausality procedure proposed by Toda and Yamamoto (1995) and monthly data for the January 1994 to April 2002 period, two important findings emerge. First, hedge funds lead Thai baht during the 1997 crisis. Second, there is a bidirectional causality between hedge funds and Malaysian ringgit for the pre-crisis period. In all other cases, no causal relation can be established.
Recent studies argue that the spread-adjusted Taylor rule (STR), which includes a response to the credit spread, replicates monetary policy in the United State. We show (1) STR is a theoretically optimal monetary policy under heterogeneous loan interest rate contracts in both discretionay and commitment monetary policies, (2) however, the optimal response to the credit spread is ambiguous given the financial market structure in theoretically derived STR, and (3) there, a commitment policy is effective in narrowing the credit spread when the central bank hits the zero lower bound constraint of the policy rate.
The net buying (selling) volume of the most net buyer (seller) brokers over a unit period is a widely followed piece of information in Istanbul Stock Market, which most market commentaries inaccurately refer to as “the net money in- or outflow”. It is, in fact, a proxy for big investors’ trading. In this note, we test whether this information has predictive value, whether market participants’ emphasis on this information is justified, or just an illusion. By doing so, we add to the literature on the relationship between big investors’ trading and stock returns, using a unique information set. Results suggest a significant contemporaneous association between the “net inflow” and current returns, but little predictive value
L'int�r�t de l'approche par les jeux globaux ("global games'') est pr�cis�ment d'ancrer les anticipations sur des variables exog�nes r�elles. On peut ainsi garder l'aspect auto-r�alisateur des anticipations mais en restaurant l'unicit� de l'�quilibre et donc un meilleur pouvoir pr�dictif du mod�le. Nous illustrons ces m�canismes sur deux exemples. Le premier a trait au choix r�sidentiel d'agents qui ont une pr�f�rence "identitaire''. Le second a trait � la contagion de paniques bancaires d'un pays � un autre. De mani�re plus g�n�rale, tous les jeux qui pr�sentent des compl�mentarit�s strat�giques sont susceptibles d'�tre analys�s au moyen des techniques des "global games''. Il convient toutefois de rappeler que les techniques utilis�es demeurent assez sp�cifiques: l'incertitude strat�gique porte essentiellement sur les croyances de premier degr� des autres acteurs. Or, si de mani�re plus g�n�rale on suppose que cette incertitude peut porter sur des ordres plus �lev�s, les conclusions des mod�les peuvent changer. Ainsi, Weinstein et Yildiz (2004) montrent que dans un oligopole de Cournot, il y a une tr�s grande multiplicit� d'�quilibres si on suppose que l'incertitude porte sur les croyances de niveaux suffisamment �lev�s.
This paper looks at speculative behavior in one of the largest, and most volatile, international financial markets, petroleum derivatives. It utilizes a large, detailed database on individual trader positions in crude-oil and heating-oil futures markets. The paper is exploratory, focusing on measuring and assessing the tendency of speculators to herd.
We analyze the trading activity of the mutual fund industry from 1975 through 1994 to determine whether funds "herd" when they trade stocks and to investigate the impact of herding on stock prices. Although we find little herding by mutual funds in the average stock, we find much higher levels in trades of small stocks and in trading by growth-oriented funds. Stocks that herds buy outperform stocks that they sell by 4 percent during the following six months; this return difference is much more pronounced among small stocks. Our results are consistent with mutual fund herding speeding the price-adjustment process. Copyright The American Finance Association 1999.
In existing models of information acquisition, all informed investors receive their information at the same time. This article analyzes trading behavior and equilibrium information acquisition when some investors receive common private information before others. The model implies that, under some conditions, investors will focus only on a subset of securities ('herding'), while neglecting other securities with identical exogenous characteristics. In addition, the model is consistent with empirical correlations that are suggestive of oft-cited trading strategies such as profit taking (short-term position reversal) and following the leader (mimicking earlier trades). Copyright 1994 by American Finance Association.
Hedge funds often employ opportunistic trading strategies on a leveraged basis. It is natural to find their footprints in most major market events. A “small bet” by large hedge funds can be a sizeable transaction that can impact a market. This study estimates hedge fund exposures during a number of major market events. In some episodes, hedge funds had significant exposures and were in a position to exert substantial market impact. In other episodes, hedge fund exposures were insignificant, either in absolute terms or relative to other market participants. In all cases, we found no evidence of hedge funds using positive feedback trading strategies. There was also little evidence that hedge funds systematically caused market prices to deviate from economic fundamentals.
This paper documents that hedge funds did not exert a correcting force on stock prices during the technology bubble. Instead, they were heavily invested in technology stocks. This does not seem to be the result of unawareness of the bubble: Hedge funds captured the upturn, but, by reducing their positions in stocks that were about to decline, avoided much of the downturn. Our findings question the efficient markets notion that rational speculators always stabilize prices. They are consistent with models in which rational investors may prefer to ride bubbles because of predictable investor sentiment and limits to arbitrage. Copyright 2004 by The American Finance Association.
A model is developed which implies that if an analyst has high reputation or low ability, or if there is strong public information that is inconsistent with the analyst's private information, she is likely to herd. Herding is also common when informative private signals are positively correlated across analysts. The model is tested using data from analysts who publish investment newsletters. Consistent with the model's implications, the empirical results indicate that a newsletter analyst is likely to herd on "Value Line's "recommendation if her reputation is high, if her ability is low, or if signal correlation is high. Copyright The American Finance Association 1999.
Standard models of informed speculation suggest that traders try to learn information that others do not have. This result implicitly relies on the assumption that speculators have long horizons, i.e., can hold the asset forever. By contrast, the authors show that if speculators have short horizons, they may herd on the same information, trying to learn what other informed traders also know. There can be multiple herding equilibria, and herding speculators may even choose to study information that is completely unrelated to fundamentals. Copyright 1992 by American Finance Association.