Herd Behavior in Financial Markets: An Experiment with Financial Market Professionals

We study herd behavior in a laboratory financial market with financial market professionals. An important novelty of the experimental design is the use of a strategy-like method. This allows us to detect herd behavior directly by observing subjects’ decisions for all realizations of their private signal. In the paper, we compare two treatments: one in which the price adjusts to the order flow in such a way that herding should never occur, and one in which the presence of event uncertainty makes herding possible. In the first treatment, subjects herd seldom, in accordance with both the theory and previous experimental evidence on student subjects. A proportion of subjects, however, engage in contrarianism, something not accounted for by the theory. In the second treatment, the proportion of herding decisions ∗Cipriani: Department of Economics, George Washington University and IMF (e-mail: [email protected]); Guarino: Department of Economics and ELSE, University College London (e-mail: [email protected]). We thank Syngjoo Choi, Burkhard Drees, Douglas Gale, Giovanni Guazzarotti, Steffen Huck, Sjaak Hurkens, Vincenzo Guzzo, Brett Rayner and the participants in the Workshop in Industrial Organization and Finance at IESE, in the WEF Conference at Warwick, and in seminars at GWU, NYU and SMU for helpful comments and suggestions. We also thank Brian Wallace, who wrote the experimental program, and Tom Rutter, who helped to run the experiment. Guarino gratefully acknowledges the financial support of the ESRC (World Economy and Finance program). The views expressed in this paper are those of the authors and do not necessarily represent those of the IMF or IMF policy. We are responsible for any errors.