SCHOOL OF BUSINESS WORKING PAPER No. 290 A NEW MEASURE TO TEST HERD FORMATION IN EQUITY MARKETS

This paper examines the presence of herd formation in equity markets by defining a new measure for equity return dispersion. We build on Christie and Huang (1995) results and analyze security returns for the same time period using a modified version of their dispersion measure. Our results contradict with theirs. We find evidence to herding by market participants during periods of unusually large upward and downward swings. We also find no evidence in favor of the so-called directional asymmetry which suggests that herd formation occurs only during extreme down markets. Both measures of security return dispersions that we utilize are consistently lower during periods of both extreme up and extreme down market movements. JEL Classification Code: G1, G2