This paper is an attempt to examine the presence of herd behavior in the stock market of India, which is one of the emerging economies of the world. The study uses the measures suggested by Christie and Huang (1995) and Chang et al. (2000) on National Stock Exchange data. Empirical results based on daily and monthly data indicate that during periods of extreme price movements, equity return dispersions tend to increase rather than decrease, thus providing evidence against the presence of herding in the Indian stock market for the years 2000-2012. Owing to reforms in Indian stock market and the increased presence of institutional players, investors’ behavior seems to be more rational, facilitating the application of rational pricing models in the Indian stock markets.

The history of the stock market shows that most investors buy stocks in companies or mutual funds for presumably sound reasons but exit their holdings the moment the market turns against them. They sell when a bunch of complete strangers offer them less than what they had paid for their investment. Conversely, they pay high prices for stocks just because other people whom they do not know, are willing to pay such prices. The dotcom boom was a result of such thinking. In the stock market parlance, this is known as investing with the herd or herding behavior. It is a phenomenon in which less sophisticated investors imitate market gurus or seek advice from victorious investors with a mind setup that using their own information will incur less benefits and more cost. Banerjee (1992) viewed herding as everyone doing what everyone else was doing, even when their information suggested doing something different.

Herd behavior happens when all investors copy the opinions of others to modify their private beliefs. It is a response task complexity created by constraints of time, information or ability. According to Cote and Sanders (1997), various factors which may influence herding include concern over one’s reputation, forecast ability, perceived credibility of the consensus forecast and the variance among the individual opinions comprising the consensus forecast. Theoretically, herd behavior has two types of views: rational and irrational. The rational view advocates that individuals may rationally herd others whom they believe to be better informed in comparison to the market. Rook (2006) believed that herding is rational and subconscious but linked to a human need for conformity. On the other hand, when an investor behaves like a lemming and foregoes rational analysis, it leads to irrational herd behavior. According to Christie and Huang (1995), herding is a tendency of investors who irrationally ignore their own analysis and information and conform to the market consensus, even if they do not agree with it. Investors do so because it reduces their uncertainty and fulfills their need to feel confident (Vaughan and Hogg, 2005). Both explanations of herding behavior highlight that investors do not follow their own beliefs and analysis, but follow the market consensus.

Applied Finance Journal, National Stock Exchange data, Indian stock markets, Chinese Stock Markets data, Herding Behavior, Emerging Stock Market, Foreign Institutional Investors (FIIs), cross-sectional standard deviation (CSSD), Evidence from India.