HERD BEHAVIOUR

Is Herd Behaviour Rational Or Irrational?

Is Herd Behaviour Rational or Irrational?

Introduction

The behaviour of investors in recent years has been occasionally referred to as the “herd instinct”. This is associated with the most subtle insinuation that “investor who follows the herd, consider as stupid” according to new study of behavioural finance researchers at the University of Mannheim shows, that this conclusion is premature due to that herd behaviour may be quite rational.

This has been demonstrated which might be somewhat surprising, an example of a Russian loan. Equipped with a coupon of nine percent a German buyer Mark first had no currency and exchange risk as the bonds fluctuated at the beginning of the issue price of 100 percent. In the summer of 1998 there was a devaluation of the ruble, which played like terms of the currency risk which has no role. But dwindling confidence in the creditworthiness led to price falls. This course was justified then and solely depended on the new credit risk.

Discussion

As herd behaviour refers to a financial market phenomenon. It refers to the observation that investors in their decisions like a herd and thus follow the majority in an investment property to invest or disinvest. The results of herd behaviour considered as a strong fluctuations of the respective system object. Herd behaviour is a manifestation of the so-called contagion effects and thus a cause of financial market crises (Koppel R., 2011, pp. 6).

Given the strong fluctuations in the stock market over the last two years, here question arises that to what extent parallel behaviour of investors, analysts and fund managers is rationally justifiable. Irrational herd behaviour is often used as an explanation; if there are large price movements in financial markets do not “obvious” new information. In the study, rational and irrational herd behaviour is considered as smarter sheep which are different forms of herd behaviour, classified and analyzed using examples (Lux T., 1995, pp. 881).

Rational herd behaviour in the financial market occurs when new information or fundamental conditions, such as, for example, to force the liquidation of a position due to the threat of insolvency, parallel behaviour. For example, new information leads over a degraded ability to pay Russia to ensure that all potential buyers to pay less for the bonds. In other words, bond prices falling as a consequence of the rational, parallel behaviour (Bikhchandani S., Sharma S., 2000, pp. 5).

Rectified behaviour of fund managers and analysts may also be the group relative to the performance-rationally involving compensation, even if there is no new fundamental information. If any information or conditions may explain the behaviour is rectified, against irrational herd behaviour. The often used in the past year relative valuation of companies on the basis of the current customer number is not rationally justifiable. When evaluating a telecommunications company not only used the current number of customers, but also the usage behaviour and a crucial role. As the experience of last year showed the resulting irrational herd behaviour has led to ...