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Journal Article

Multidimensional Uncertainty and Herd Behavior in Financial Markets

Christopher Avery and Peter Zemsky
The American Economic Review
Vol. 88, No. 4 (Sep., 1998), pp. 724-748
Stable URL: http://www.jstor.org/stable/117003
Page Count: 25
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Multidimensional Uncertainty and Herd Behavior in Financial Markets
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Abstract

We study the relationship between asset prices and herd behavior, which occurs when traders follow the trend in past trades. When traders have private information on only a single dimension of uncertainty (the effect of a shock to the asset value), price adjustments prevent herd behavior. Herding arises when there are two dimensions of uncertainty (the existence and effect of a shock), but it need not distort prices because the market discounts the informativeness of trades during herding. With a third dimension of uncertainty (the quality of traders' information), herd behavior can lead to a significant, short-run mispricing.

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