The purpose of this paper is to show that the level of herding in an industry can be the basis for a profitable investment strategy.
The authors apply three different herding measures in the paper, including cross-sectional standard deviation, cross-sectional absolute deviation and non-linear model – state–space model.
The authors find that industries that experience a high level of herding yield higher subsequent returns regardless of their past performance. Consequently, the authors show that a herding-based investment strategy generates significant profits, even after adjusting for risk. The findings also show that the herding effect when combined with past performance as part of a conditional investment strategy yields significant profits regardless of the formation and holding periods. The findings suggest that the level of herding could serve as a systematic driver of returns and could be exploited for profitable investment strategies.
To the best of authors’ knowledge, this is the first study in the literature to show that herding by itself can serve as a determinant of returns regardless of past performance.
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