Emerald Article: Herding, information uncertainty and investors' cognitive profile Beatriz Fernández, Teresa Garcia-Merino, Rosa Mayoral, Valle Santos, Eleuterio Vallelado
Article information:
To cite this document: Beatriz Fernández, Teresa Garcia-Merino, Rosa Mayoral, Valle Santos, Eleuterio Vallelado, (2011),"Herding, information uncertainty and investors' cognitive profile", Qualitative Research in Financial Markets, Vol. 3 Iss: 1 pp. 7 - 33 Permanent link to this document: http://dx.doi.org/10.1108/17554171111124595 Downloaded on: 18-12-2012 References: This document contains references to 62 other documents To copy this document: permissions@emeraldinsight.com This document has been downloaded …show more content…
Herding becomes relevant when such behavior persists through time. Herding must comply with two related criteria to justify behavior persistence (Daniel and Titman, 1999). The first criterion is that biases with no offsetting benefits are likely to have been eliminated over a long period of time by natural selection; but in the presence of herding, we observe offsetting benefits related to economic cycles. The second criterion is that biases which systematically make individuals less successful when investing should not play a role in setting securities prices; but when herding occurs, all individuals act identically, thus avoiding the comparison between the most and least successful. Subjects display less regret when the bias affects a large number of people (regret bias). Consequently, herding behavior will depend not only on the uncertainty present in the market, but also on each investor’s individual perception of the level of uncertainty surrounding them. Thus, in the same informational context investors who are more insecure and less confident about their sources of information are more likely to herd. This feeling of uncertainty is a characteristic of each individual, as it depends on each individual’s attitudes, their more or less intuitive character, their risk propensity, their excess or lack of confidence, their illusion of control (ILC), and their degree of tolerance for ambiguity. All of these variables, which are interrelated, make up the investor’s cognitive profile, which determines how the individual receives and interprets the different information stimuli to emerge from their environment. Consequently, individuals’ cognitive profiles will also be determinant in explaining in what circumstances investors decide to ignore their private information and to imitate majority decisions in the market. 2.3 Identification of behavioral biases Having recognized the importance of cognitive profile in accounting for herding