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Herd Behavior and Investment: Reply

Herd Behavior and Investment: Reply By DAVID S. SCHARFSTEIN In our 1990 paper, we showed that managers concerned with their reputations might choose to mimic the behavior of other managers and ignore their own information. We presented a model in which “smart” managers receive correlated, informative signals, whereas “dumb” managers receive independent, uninformative signals. Managers have an incentive to follow the herd to indicate to the labor market that they have received the same signal as others, and hence are likely to be smart. This model of reputational herding has subsequently found empirical support in a number of recent papers, including Judith A. Chevalier and Glenn D. Ellison’s (1999) study of mutual fund managers and Harrison G. Hong et al.’s (2000) study of equity analysts. We argued in our 1990 paper that reputational herding “requires smart managers’ prediction errors to be at least partially correlated with each other” (page 468). In their Comment, Marco Ottaviani and Peter Sørensen (hereafter, OS) take issue with this claim. They write: “correlation is not necessary for herding, other than in degenerate cases.” It turns out that the apparent disagreement hinges on how strict a definition of herding one adopts. In particular, we had defined a herding equilibrium http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png American Economic Review American Economic Association

Herd Behavior and Investment: Reply

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Publisher
American Economic Association
Copyright
Copyright © 2000 by the American Economic Association
Subject
Shorter Papers
ISSN
0002-8282
DOI
10.1257/aer.90.3.705
Publisher site
See Article on Publisher Site

Abstract

By DAVID S. SCHARFSTEIN In our 1990 paper, we showed that managers concerned with their reputations might choose to mimic the behavior of other managers and ignore their own information. We presented a model in which “smart” managers receive correlated, informative signals, whereas “dumb” managers receive independent, uninformative signals. Managers have an incentive to follow the herd to indicate to the labor market that they have received the same signal as others, and hence are likely to be smart. This model of reputational herding has subsequently found empirical support in a number of recent papers, including Judith A. Chevalier and Glenn D. Ellison’s (1999) study of mutual fund managers and Harrison G. Hong et al.’s (2000) study of equity analysts. We argued in our 1990 paper that reputational herding “requires smart managers’ prediction errors to be at least partially correlated with each other” (page 468). In their Comment, Marco Ottaviani and Peter Sørensen (hereafter, OS) take issue with this claim. They write: “correlation is not necessary for herding, other than in degenerate cases.” It turns out that the apparent disagreement hinges on how strict a definition of herding one adopts. In particular, we had defined a herding equilibrium

Journal

American Economic ReviewAmerican Economic Association

Published: Jun 1, 2000

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