A Basic Theory of Rational Herd Behavior and Informational Cascades - Does it Apply to Financial Markets?

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Journal Title
Journal ISSN
Volume Title
School of Business | Bachelor's thesis
Date
2017
Major/Subject
Mcode
Degree programme
Taloustiede
Language
en
Pages
25
Series
Abstract
Abstract This paper pursues to motivate and intrigue towards a research of theories of rational herd behavior. The basic theories of rational herd behavior and informational cascades are introduced by using examples and reviewing the most recognized research studies of rational herd behavior by Banerjee (1992), Bikhchandani, Hirshleifer & Welch (1992&1998) and Chamley (2004). It is shown that herding can be modeled with rational individuals using the Bayes’ theorem as their decision rule. This model is tested through empirical research, which gives us somewhat controversial evidence of the existence of informational cascades and, though almost all of them find herding to be present, they do not always second the assumption of rational individuals. Towards the end of the paper an implementation of the herd behavior theory to the financial markets is introduced and it is showed, that through the impact of herd behavior and with some extra assumptions to the theory there lies a state where herding occurs in the financial markets giving birth to a price bubbles. It is shown that there is a lot of robust research done among the herd behavior but more evidence to support some conclusions is still needed.
Description
Thesis advisor
Mustonen, Mikko
Murto, Pauli
Keywords
rationality, herd, behavior, informational, cascade, financial, markets, Bayes
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