London School of Economics EOPP: Economic Organisation and Public Policy Programme LSE
EOPP: Economic Organisation and Public Policy Programme

Current EOPP Research:
The Price Impact of Institutional Herding

Andrea Prat (with Amil Dasgupta, LSE and Michela Verardo, LSE)

Abstract:

We present a simple theoretical model of the price impact of institutional herding. In our model, career-concerned fund managers interact with profit-motivated proprietary traders and monopolistic market makers in a pure dealer-market. The reputational concerns of fund managers generate endogenous conformism, which, in turn, impacts the prices of the assets they trade. In contrast, proprietary traders trade in a contrarian manner. We show that, in markets dominated by fund managers, assets persistently bought (sold) by fund managers trade at prices that are too high (low) and thus experience negative (positive) long-term returns, after uncertainty is resolved. The pattern of equilibrium trade is also consistent with increasing (decreasing) short-term transaction-price paths during or immediately after an institutional buy (sell) sequence. Our results provide a simple and stylized framework within which to interpret the empirical literature on the price impact of institutional herding. In addition, our paper generates several new testable implications.

Related Paper

The Price Impact of Institutional Herding