Rational Herd Behavior and the Globalization of Securities Markets
Duke Economics Working Paper No. 97-26
46 Pages Posted: 13 Aug 1998
Date Written: March 6, 1998
This paper shows that globalization of securities markets exacerbates the volatility of capital flows by strengthening incentives for herding behavior. This is a prediction of a mean-variance portfolio optimization model with imperfect information, in which investors acquire country-specific expertise at a fixed cost and incur variable reputational costs. The model produces equilibria in which incentives to confirm rumors decrease with globalization. Simulations based on equity markets data and country credit ratings suggest that herd behavior can induce large capital outflows from emerging markets.
JEL Classification: F30, F34, F36, G11, G15
Suggested Citation: Suggested Citation