Option‐implied information and stock herding

• Date: 01 October 2019
• Author: Nikolaos Voukelatos,Thanos Verousis
• DOI: http://doi.org/10.1002/ijfe.1741
• Published date: 01 October 2019

RESEARCH ARTICLE

Option-implied information and stock herding

Nikolaos Voukelatos

1

| Thanos Verousis

2

1

Kent Business School, University of Kent,

Canterbury, UK

2

Essex Business School, University of

Essex, Colchester, UK

Correspondence

Thanos Verousis, Essex Business School,

University of Essex, Colchester, UK.

Email: t.verousis@essex.ac.uk

Abstract

In this paper, we examine if herding behaviour in the equity market can be

explained by option-implied information. Our empirical results confirm the com-

monly reported absence of herding as a general tendency in the U.S. equity market.

However, we find evidence of significant herding behaviour during periods when

option-implied information reflects a pessimistic view about the future prospec ts of

the equity market. More specifically, we find that individual stock returns tend to

cluster more closely around the market consensus during days of high implied

index volatility, more pronounced negative implied skewness, and higher trading

volume in index puts.

KEYWORDS

cross-sectional dispersion, herding, market stress, options

JEL CLASSIFICATION

G14; G11

1|INTRODUCTION

The behavioural finance literature has been paying increas-

ing attention to the way in which investors form beliefs about

the future evolution of asset prices and, ultimately, how they

trade based on these beliefs. One stream of the literature, in

particular, has focused on the potential tendency of investors

to follow some type of aggregate consensus, a behaviour

typically referred to as herding. For instance, investors could

exhibit herding behaviour when trading a particular stock by

following the actions of other investors who trade the same

stock. Alternatively, investors might use the aggregate

market return as a consensus around which to herd when

they price individual stocks.

From a psychological point of view, suppressing one's

prior beliefs in order to follow the actions of others could

reflect an irrational behaviour (Devenow & Welch, 1996).

However, herding could also represent a rational strategy for

a less sophisticated investor who faces high costs of informa-

tion (Chiang & Zheng, 2010). In this case, mimicking the

actions of more sophisticated investors or following the over-

all market consensus could be more efficient compared to

collecting and analysing information in order to form inde-

pendent views about asset prices. Importantly, suppressing

individual beliefs in favour of following the prevailing con-

sensus has significant implications. Pricing assets by follow-

ing the market consensus is likely to lead asset prices to

deviate considerably from their true fundame ntal values,

whereas herding also mechanistically increases correlations

among assets, thereby reducing diversification benefits.

Currently, there is a substantial literature that examines

the topic of herding in equity markets (see Spyrou, 2013, for

a comprehensive review of the literature).

1

Generally, the

1

In addition to the substantial literature on herding in the equity market (see

Andrikopoulos, Kallinterakis, Ferreira, & Verousis, 2017 and Frijns &

Huynh, 2018 for two recent studies), other empirical studies have examined

herding effects in other markets, such as mutual funds (Grinblatt, Titman, &

Wermers, 1995; Jiang & Verardo, 2018), ExchangeTraded Funds (Gleason,

Mathur, & Peterson, 2004), corporate bonds (Cai, Han, Li, & Li, 2019),

commodities (Demirer, Lee, & Lien, 2015), and options (Bernales,

Verousis, & Voukelatos,2016).

DOI: 10.1002/ijfe.1741

This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distr ibution and reproduction in any medium, provided the original

work is properly cited.

© 2019 The Authors International Journal of Finance & Economics Published by John Wiley& Sons Ltd

Int J Fin Econ. 2019;24:1429–1442. wileyonlinelibrary.com/journal/ijfe 1429