Herding by corporates in the US and the Eurozone through different market conditions

Systemic Risk and Portfolio Diversification: Evidence from the Futures Market

“…These results are consistent with information contagion among large banks or "behavioral" herding effects (Duygun, Tunaru and Vioto, 2021;Nofsinger and Sias, 1999;Welch, 2000;Hwang and Salmon, 2004). However, increased commonality could also be a rational response to market illiquidity when portfolio liquidation costs are systemic (Wagner, 2011).…”

“…Since the only remaining type of market participant are the investment clients of large banks, this means that the core banks were trading against a periphery consisting mostly of investment clients 13 and (partly) of non-core banks, rather than amongst themselves. 14 That made core banks much more susceptible to contemporaneous losses. This result is consistent with previous studies, which have found that investment clients of US firms account for significant portion of this market (Raykov, 2021); our finding additionally clarifies that these clients were also on the opposite side of the core banks.…”

“…This could be due to a number of different mechanisms proposed in the literature. For example, a strain of papers focused on herding (Duygun et al, 2021;Nofsinger and Sias, 1999;Welch, 2000;Hwang and Salmon, 2004) attributes this to investor beliefs that the rest of the market has superior information. In our setting, this would imply information contagion amongst core banks, and less so amongst non-core banks.…”

“…However, this theory does not explain the source of information contagion among banks, given the extraordinary precautions they take to protect their proprietary trading strategies. 15 Instead, information contagion appears much more prevalent amongst retail investors (Duygun et al, 2021). 16 Other explanations are offered by the theories of Acharya (2001) and Acharya and Yourlmazer (2005, 2006, 2007, where limited liability or incentives to be bailed out can induce banks to undertake correlated investments -in the former two papers, because banks do not internalize the costs of joint failure, and in the latter two, because banks are more likely to be bailed out if they fail simultaneously.…”

“…In Wagner (2010), banks dislike being correlated, but interbank commonality arises as an unwelcome side effect of diversification. By contrast, a different literature focused on herding (Duygun et al, 2021;Nofsinger and Sias, 1999;Welch, 2000;Hwang and Salmon, 2004) perceives common investments as a phenomenon arising from investors believing that the rest of the market has superior information. In line with this literature, we find that similar investments increased during the crisis.…”