What Causes Herding : Information Cascade or Search Cost?

We analyze in this study cause of herding in a stock market. Information cascades have often been considered as a primary choice. However, we propose alternative explanations in this study. Employing intraday order book data, we suggest including an alternative theory based on search cost of investors, in addition to the information cascade argument. Specifically, previous works used data with daily or lower frequency based on a herding measure of Lakonishok, Shleifer, and Vishny (1992). We adopt instead a measure by Patterson and Sharma (2006) and argue that the search model of Vayanos and Wang (2007) characterizes herding phenomenon better, especially at market open. Our analysis is also consistent with the information competition equilibrium of Back, Cao and Willard (2000) and dynamic friction model of Hu (2006). We find that stronger order flow herding takes place when buyers and sellers are 6 times higher as well as when buyer-seller ratio is 50% higher, and is driven by lower transactions cost and shorter order-filling time. Herding tends to occur in trading of high-cap, high turnover stocks, which contradicts prediction of the information cascade hypothesis. Search cost effect is stronger at market open, while information cascade effect is stronger at market close. Therefore our study suggests that herding should be related both to intrinsic search cost structure of investors as well as information related factors