Herding and positive feedback trading on property stocks
| DOI | https://doi.org/10.1108/14635780810857872 |
| Date | 07 March 2008 |
| Pages | 110-131 |
| Published date | 07 March 2008 |
| Author | Rhea Tingyu Zhou,Rose Neng Lai |
Herding and positive feedback
trading on property stocks
Rhea Tingyu Zhou and Rose Neng Lai
Department of Finance and Business Economics,
Faculty of Business Administration, University of Macau, Taipa, Macao
Abstract
Purpose –Motivated by the unique characteristics and profit generating nature of real estate
investments, this paper aims to study if investors herd differently in corresponding securities versus
other non-real estate securities.
Design/methodology/approach – The authors choose the Hong Kong stock market to form the
sample to distinguish the herd behavior of the property stocks, if any, from stocks of other categories.
The authors separate stocks into two portfolios, those made up of property stocks versus non-property
stocks, because it is widely known that property stocks have high market volatility and domination of
institutional investors.
Findings – The authors find a persistent and significant smaller herding in property stocks. The
result of a reverse U-shape intraday herding pattern also provides a possible clue to previous studies of
a U-shape in intraday volatility pattern. The authors document that recent announcements of an
increase in the short-term interest rate have an additive effect on the herd behavior of market
participants in trading property stocks. Lastly, on the conjecture that herding will further exemplify
price instability arising from positive feedback trading while investors engage in positive feedback
trading in both property stocks and non-property stocks, such activity in the latter group lasts for a
longer period. Furthermore, price instability of property stocks disappears at a faster pace than the
counterpart.
Originality/value – This study shows that property stocks are more efficiently traded by investors
than other types of stocks, at least in the Hong Kong stock market.
Keywords Property, Stocks,Securities, Hong Kong
Paper type Research paper
1. Introduction
In price discovery process, price movements of stocks reflect the information flows of
direct investment by companies. In addition, market efficiency is a pivot in
determining whether the stock prices correctly reflect the fundamental prices of the
underlying assets. This however is under the assumption that the market is affected by
rational market participants who form rational expectations of future perspectives and
discount all market information into expected prices simultaneously. On the other
hand, it is widely known that herding and positive feedback trading are potential
causes of some phenomena in financial markets such as asset price momentum, excess
volatility and bubbles. Herding, a tendency for investors to trade as a group inherently,
form when investors’ activities are highly correlated. Positive feedback trading, which
is traders buying when prices have increased and selling when they have fallen, can be
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1463-578X.htm
The authors would like to thank David Hirshleifer, Kim Hiang Liow (co-Guest Editor) and the
two anonymous referees for their very helpful comments. This research is supported by the
research grant of the University of Macau, reference number RG012/05-06S/LN/FBA. The
authors are solely responsible for any remaining errors in the paper.
JPIF
26,2
110
Received July 2005
Accepted April 2007
Journal of Property Investment &
Finance
Vol. 26 No. 2, 2008
pp. 110-131
qEmerald Group Publishing Limited
1463-578X
DOI 10.1108/14635780810857872
considered as a special case of herding[1]. Existence of both thus exemplify the
bubbles, destabilize prices, and push stock prices further away from the fundamentals.
Most theoretical models study herding and positive feedback trading of
institutional investors, especially financial analysts (see, for example, Scharfstein
and Stein, 1990; Froot et al., 1992; Roll, 1992; Hirshleifer et al., 1994; Trueman, 1994;
Graham, 1999). For empirical studies, literature on institutional behavior mostly
focuses on mutual funds or pension funds (see, for example, Lakonishok et al., 1992;
Wermers, 1999; Voronkova and Bohl, 2005; Wylie, 2005), and financial analysts (see,
for example, Graham, 1999; Welch, 2000; Tamura, 2002; Clement and Tse, 2005).
Others such as Choe et al. (1999), Bowe and Domuta (2004), and Ghysels and Seon
(2005) concentrate on the impact of herding among foreign investors during the 1997
financial crisis; while Chang et al. (2000), and Demier and Kutan (2005) focus on the
trading behavior in emerging markets. Although previous study (see Chang et al.,
2000) reveals an absence of herding in some developed markets, it does not preclude
that herding is short-lived and exists in a certain industry. There is however scant
study, if any, on any particular stock sector in a stock market. The purpose of the study
is therefore to distinguish herd behavior and positive feedback trading in property
stocks from those in other stocks in the Hong Kong stock market.
We focus on property stocks because real estate investments are characterized as
illiquid, expensive, having long market cycles, and having values that are hard to
appraise. We raise the question of whether investors react differently to securitized real
estate investments. In particular, we choose two aspects of investors’ behavior, namely
herding and positive feedback trading. From the market microstructure point of view,
we empirically study how investors invest on securitized real estate investments, and
compare the herd behavior and positive feedback trading with those in other securities.
We choose the Hong Kong stock market as our sample because, in addition to Hong
Kong being one of the major financial centers in the world, the property market in
Hong Kong is distinct in terms of high prices, high demand owing to scarce land
supply, high price volatilities, and the very influential role played in the economy.
Ideally, real estate investment trusts (REITs) are the best representatives for the tests
because the underlying assets are purely made up of real estate investments. However,
because REITs in Hong Kong have relatively short history, we have to focus on stocks
classified as “property and construction companies” by the Hong Kong Stock
Exchange, although part of their income generating sources might not be related to real
estate[2]. Notice that even though the classification is named as “property and
construction”, none of the property stocks included in this study is construction
companies, thereby avoiding irrelevant stocks that have pricing fundamentals
different from those of property stocks.
The study consists of three groups of analyses. First, we follow former literature to
study and compare the extent of herding in property stocks versus non-property
stocks. We perform analyses from both the inter-day and intra-day perspective.
Second, while the stock market in general is sensitive to changes in interest rates,
property stocks tend to be more prone to the effect. It is probable that investors may
herd more in trading property stocks in order to preempt or avoid the more sensitive
stock price changes due to changes in interest rates. We therefore further test whether
increases in short-term interest rate will induce more herding in property stocks
relative to their counterparts. Finally, given the existence of herding, positive feedback
Herding and
positive feedback
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