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IJOEM
10,3
474
Received 20 July 2011
Revised 16 November 2011
Accepted 14 January 2012
International Journal of Emerging
Markets
Vol. 10 No. 3, 2015
pp. 474-490
© Emerald Group Publishing
Limited 1746-8809
DOI 10.1108/IJoEM-07-2011-0064
An examination of herding
behavior in Pakistani stock market
Zuee Javaira
Department of Business Administration,
Federal Urdu University of Arts Science and Technology,
Islamabad, Pakistan, and
Arshad Hassan
Faculty of Management and Social Sciences,
Mohammad Ali Jinnah University, Islamabad, Pakistan
Abstract
Purpose – The purpose of this paper is to examine the investment behavior of Pakistani stock market
participants, specifically with respect to their tendency to exhibit herd behavior.
Design/methodology/approach – The study employed two different methodologies suggested by
Christie and Huang (1995) and Chang et al. (2000) to test herd formation. Results are based on daily
and monthly stock of KSE-100 index for the period 2002-2007.
Findings – Results based on daily and monthly stock data from Karachi Stock Exchange indicate the
non-existence of herd behavior for the period 2002-2007 and find no support for the rational asset
pricing model and investor behavior found inefficient. This study denied proved evidence of herding
due to market return asymmetry, high and low trading volume states and asymmetric market
volatility. Macroeconomic fundamentals have insignificant role in decision-making process of
investor therefore has no impact on herding behavior. However, during liquidity crisis of March
2005, Pakistani stock market exhibit herding behavior due to asymmetry of information among
investors, presence of speculator and questionable badla financing-local leverage financing
mechanism.
Research limitations/implications – In future, this study can be improved by employing stock returns
portfolios based on market capitalization or sector wise portfolio returns from KSE-100. Furthermore by
identifying those factors that cause market to be overall inefficient and define the pattern of the investor
trading activities.
Practical implications – For an accurate valuation of assets investors should incorporate the
herding factor.
Social implications – As the assets are mispriced, investor behavior is uncertain and markets are
inefficient, foreign investors should invest with caution, as large numbers of securities are needed to
achieve the same level of diversification than in an otherwise normal market.
Originality/value – In Karachi Stock Exchange, it is first attempt to uncover the herding behavior.
This paper contribute to the body of knowledge by investigating the herding behavior in the emerging
markets since most of the previous study concentrate more on the developed markets. Furthermore, the
study also analyzed the herding behavior in different economic condition and includes economic
variables and examines asymmetric effect. This study presents an integrated model to test herding
behavior in Pakistani equity market. Consideration of said behavioral effect in the decision-making
process of investor will make the decisions more rational and optimal.
Keywords Herd behaviour, Pakistan Stock Exchange, Equity returns dispersion,
Asymmetric behaviour
Paper type Research paper
1. Introduction
Trading pattern of investors and its effect on pricing mechanism has always been
debatable to academics and practitioners. For a long time, academicians believed that
efficient market hypothesis dominated the functioning of equity market Fama (1970).
Presence of excess volatility in expected returns points to the intrinsic dynamic forces of
speculative markets
not related to fundamental factors and turned the focus of researcher back to
reexamining the empirical puzzles not addressed in EMH. West (1988) suggests models Examination
such as fads, sociological and psychological mechanisms may affect the pricing of herding
dynamics of stock markets. Kindleberger (1996) highlights the importance of behavior
psychological and irrational factors in explaining historical financial crisis. Herding is
one of these behavioral factors. Kindleberger (1996) and Galbraith (1993) believe that
evidence of bubbles and crashes are due to the mass errors caused by the fickle natures
of herd formation. 475
When applied to financial markets, herding is considered as the most important
concept in cognitive economics, that affect the pricing mechanism and trading decision
of investors. Imitative behavior in capital markets is called “herding.” Banerjee (1992)
defines herding as “everybody doing what everyone else is doing even when their private
information suggests doing something else.” Herd formation causes prices to deviate
from fundamental value, aggravate volatility of returns, destabilize financial markets, may
exacerbate the crises and eventually increases the fragility of the financial system. These
associated behavioral effects on stock price movements may affect their risk and return
characteristics and thus have implications for asset pricing models (Tan et al., 2008).
According to our knowledge, this study is the pioneering work to identify the presence
of herding behavior in Pakistani stock market and it explores the possible implications of
different levels of herding in Karachi Stock Exchange. Therefore, empirical relationships
are examined among herding intensity, trading volume and stock market volatility.
The findings of the study may be highly relevant in achieving a better understanding of
market functioning and can serve both academics and practitioners. Given that an
understanding of level of herding and nature of their influence, it can contribute to more
accurate valuation, forecasting and may add to the definition of new risk measures while
taking investment decision.
The rest of the paper is organized as follows. Section 2 covers a brief review of
literature, Section 3 describes data and Section 4 presents relevant methodology.
In Section 5 empirical results are presented and discussed. Section 6 concludes the
paper.

2. Literature review
The existence of herd behavior among investors in speculative markets is subject to
number of views. According to Devenow and Welch (1996) there are two polar views on
herding, rational and irrational. The former is based on externalities, where access to
information or incentive issues may distort the optimal decision making of an investor.
The later pertains to investor’s psychology, where investors follow the actions of others
blindly by simply ignoring rational analysis. According to intermediate view the investor
are somewhat or near rational, by avoiding information acquisition cost they use heuristic
approach for decision-making process.
Two streams of theories identified in literature to investigate the herding behavior,
one is herding toward a particular stock and other is market-wide herding. According
to herding toward particular stock, individuals or a group of investors focus only on a
subset of securities at the same time by neglecting other securities with identical
characteristics. Several models of this type have been emerged. For instance, Banerjee
(1992), Bikhchandani et al. (1992) and Welch (1992), used a model of informational
cascades to explain short-lived phenomena such as fads and fashions. According to
Bikhchandani et al. (1992) an informational cascade appears when investor makes
optimal choice by imitating the behavior of preceding investors without relying on his
personal information. The probability of taking wrong action is still present even if all
participants as a collective have overwhelming information in favor of right action.
IJOEM Lakonishok et al. (1992), Nofsinger and Sias (1999), Wermers (1999) and Shiller and
10,3 Pound (1986) investigate the herding behavior among institutional investors. They
measure herding as an excessive concentration of transactions on the same side of the
market for particular stocks. Institutions herd either by inferring information about the
quality of investments from each other’s trades or because of objective difficulties in
evaluating money managers’ performance. This sometimes create agency problem
476 between institutional money managers and fund sponsors by separating “luck” from
“skill”.
Scharfstein and Stein (1990), Trueman (1994) and Zwiebel (1995), provide another
theory of herding based on the reputational concerns of fund managers or analysts.
According to Morck et al. (2000) managerial performance evaluation within industry is
relative to the firm performance with overall industry. Poor performance can result in
firing of top managers. Therefore, the reputational concern agents mimic the action of
others by relying on their evaluation and simply ignore private information in order to
show their ability as an efficient agent.
Brennan (1993), and Roll (1992) developed a model for compensation-based herding.
According to Brennan (1993) the compensation of an agent (investment manager) is
dependant on comparison of his performance with that of other professionals. This may
distort agent’s incentive and agent can end up with inefficient portfolio. This behavior
may also lead to herd formation. One class of researcher focussed on behavioral aspect
of herding, Conlisk (1980), Pingle (1995) and Lux (1995), specifically dealing with
investor psychology, interpersonal communication or contagion of interest that is due to
non- rational decision making.
The second stream of research is focussed on market-wide herding where investors
follow market trends and tend to move with the actions of market (Chang et al., 2000;
Christie and Huang, 1995). Christie and Huang (1995) adopt an approach by empirically
investigating herding in equity returns. Chang et al. (2000) modified Christie and Huang
(1995) model and develop a more sensitive means of identifying herding in stock returns
by including an additional regression parameter. These models are widely investigated in
different markets and mixed evidence of herd formation is reported. It is observed that
herding is more prevalent in emerging markets than developed markets.
Christie and Huang (1995) find no evidence of herding in USA. Chang et al. (2000),
Oehler and Chao (2002) investigate the presence of herding behavior in foreign markets.
Chang et al. (2000) studied USA, Hong Kong, Japanese, South Korean and Taiwanese
markets and reported herding in developing countries whereas this phenomenon was not
observed in developed countries. This tendency was attributed to availability of better
information and use of high-quality analytical tools by sophisticated investors in
developed markets. In emerging markets, herding may be a result of lack of reliable
micro-information. Speculators with relatively short investment horizons dominate South
Korean and Taiwanese markets so such microstructure may lead to herding. Froot et al.
(1992) also supported the argument that the presence of short-term speculators may lead to
informational inefficiencies. Chang et al. (2000) also argued the dissimilarity in herd
behavior might be the outcome of a relatively high degree of government intervention in
the emerging financial markets.
Gleason et al. (2004) use intraday US Exchange Traded Funds data to examine
traders herd during periods of extreme market movements and find no evidence of
herding in this specialized market. Caparrelli et al. (2004) reported herding in Italian
market in extreme market conditions and linked it to market uncertainty. Henker et al.
(2006) analyzes the model using intraday data in Australian equity market and report no
evidence of herding. He stated that presence of uncertainty about the accuracy of
information possessed by
market participants may lead inefficiency of market and herd behavior arises even
among rational investors. Demirer and Kutan (2006) applied Christie and Huang (1995) Examination
model in Chinese stock market and find evidence against herding. Cajueiro and Tabak of herding
(2009) used Chang et al. (2000) model to investigate herding in Japanese stock market behavior
and herding was observed during period of extreme price movements.
Caporale et al. (2008) reported the presence of herd behavior in Greek market before
and after 1999 market crisis. However, a more rational behavior was observed after
2002. This change was attributed to the regulatory and institutional reforms of the 477
Greek equity market and the diffuse presence of foreign institutional investors.
Economou et al. (2011) studied Greek, Italian, Portuguese and Spanish stock markets
and provided evidence of herding in only in Portuguese stock market. Blasco et al.
(2012) examine herding behavior in Spanish stock market.
Tan et al. (2008) observed herding in Chinese A and B class shares and reported
that government-owned companies stock exhibit less herding whereas small privately
owned stock exhibit more herding. It argued that investor may have perception that
when the market falls, investors tend to herd less, as they believe that the government
will intervene and prevent the market from falling. Presence of institutional investors
in B shares market from developed markets aggravates herding intensity. Tan et al.
(2008) also considered the presence of foreign institution investors as source of
aggravating herding intensity. Lao and Singh (2011) reported herding in Chinese and
Indian market and stated that it was more prevalent in Chinese market. However, Lao
and Singh (2011) contradicts Tan et al. (2008) and are of the view that the foreign and
institutional investors are more rational and educated and less likely to herd. They
further argued that presence of institutional investors brings more rationality and
decreases the level of speculative investment activities in the equity market and thus
contribute to the less significant herding behavior in the Indian market.
It may be said that herding is more prevalent in emerging markets where asymmetry
of information is high and market have reasonably large number of speculators who
invest in short term. Some foreign investor also aggravate herding when they enter the
market in short run. Government frequent intervention in markets also creates
inefficiency and weak and less-developed microstructures also promote herding. In
developed markets, intensity of herding is low due to presence of institutional investors
and better flow of information to decision makers. Other reasons for less herding may be
less intervention of government and mature market practices.
This paper examines herd behavior in Pakistani stock market by employing
methodologies used by Christie and Huang (1995), Chang et al. (2000) and Gleason et
al. (2004). As Pakistani stock market is an emerging market, characterized by high
volatility, high market concentration, high returns and relative inability to mobilize new
investment. Therefore, this study analyzes the herding behavior in different economic
condition and also examines asymmetric behavior in different market conditions.
Therefore, probability of herd formation in Pakistani stock market is high.

3. Data and methodology

This study investigates the presence of herding in Pakistani stock market employing the
methodology used by Christie and Huang (1995), Chang et al. (2000) and Gleason et al.
(2004). In response to extreme changes in market conditions, these methodologies focus
on the cross-sectional correlation dispersion in stock returns. Empirical work on the
subject reveals that investors in emerging markets are more likely to demonstrate
herding behavior due to presence of information asymmetry. These methodologies are
based on
IJOEM cross-sectional standard deviation (CSSD) and cross-sectional absolute deviation
10,3 (CSAD) among market returns. In order to test herd behavior Christie and Huang (1995)
used CSSD as a measure of the average proximity of individual asset returns to the
realized market average. Chang et al. (2000) used CSAD to examine the relationship
between the overall market returns and the level of equity returns dispersion in a non-
linear regression specification. Whereas Gleason et al. (2004) used both CSSD and
478 CSAD to capture herding in overall market conditions.
While CSSD and CSAD are widely used measures to test herd behavior and these
measures capture herding of market participants or groups of investors through security-
specific returns, other measures have also been used by Wagner (2002) used Lux-
Marchasi Model and Hwang and Salmon (2004) in different model structures.

Data description
The data for this study comprises daily and monthly closing prices and trading volumes of
KSE-100 index constituents for the Pakistani market as of December 2008. The KSE-
100 is a market value weighted index consisting of 100 companies that covers 86 percent
of market capitalization at the Karachi Stock Exchange.
The study includes 774 observations of daily returns and trading volumes covering
the period June 1, 2004 to July 31, 2007. Based on market capitalization, daily data of
72 and monthly data of 71 out of 100 companies fulfilled the sample requirements.
Total of 59 monthly returns and trading volume observations are studied the for the
period July 2002 to June 2007. The historical data is obtained from the web sites
www.brecorder.com and www.fnetrade.com.

Calculation of stock returns

The observed stock return for individual firm shares is calculated as:
Pt
Ri t ¼ lnΣ Σ ~ 100
;
Pt—1
where Ri,t is the observed stock return of firm i at time t, and Pt and P—t 1 are the closing
price of the individual stock at time t and t—1, whereas cross-sectional average stock of
N returns (Rm,t) is calculated by taking average of all individual stock returns at time t:
P
Ri;t
Rm;t ¼
N
where Ri,t is the observed stock return of firm i at time t, and N is number of firms
included in the sample.

4. Methodology
This empirical investigation is based on the methodology used by Christie and Huang
(1995), Chang et al. (2000) and Gleason et al. (2004). In order to detect herd behavior
Christie and Huang (1995) measure average proximity of the realized market returns
to individual asset returns by using CSSD, which is expressed as follows:

vuffi ffiNffiffiffiffi ffiffiffiRffiffi

ffiffiffiffiffiffiffiffiRffiffiffiffiffiffiffi
t P i;t — ffiffi. m;
i¼1
CSSDt ¼ Σ t
(1)
N—
1
where N is the number of firms in the portfolio, Ri,t is the observed stock return of
firm i at time t, Rm,t is the cross-sectional average stock of N returns in the portfolio Examination
at time t. of herding
During period of market stress herding behavior represent contradictory prediction behavior
from the traditional asset pricing model concerning the behavior of the CSSD of
returns. According to rational asset pricing model contrary sensitivities of individual
securities to the market returns results in increased dispersion, whereas presence of
herding can result in relatively lower dispersion in periods of large market 479
movements, so this study test herding by estimating the following empirical design
proposed by Christie and Huang (1995):

CSSD t ¼ aþb U DU þb L DL þe t (2)

1 t 2 t
where DtU ¼ 1, if the return on the aggregate market portfolio for the time period t lies in
L
the extreme upper tail of the returns distribution, and 0 otherwise. D¼ t 1, if the return
on the aggregate market portfolio for time period t lies in the extreme lower tail of the
returns distribution, and 0 otherwise. Thus, the presence of negative and statistically
significant β1 and β2 coefficients would indicate herd formation by market
participants. Conversely, significantly positive coefficients β1 and β2 establish the
prediction of rational asset pricing model.
An alternative methodology was proposed by Chang et al. (2000) to identify
herding. Chang et al. (2000) argue that the model proposed by Christie and Huang
(1995) requires defining what is meant by market stress. They used CSAD rather then
CSSD. CSAD can be expressed as follows:

1X .
N
CSAD t ¼ R —Rm ;t . (3)
N i¼1 i t;

The second method is based on general quadratic relationship between CSADt and Rm,t
formulated by Chang et al. (2000), this non-linear relationship is modeled as follows:

CSAD t ¼ aþg 1. R m;t. þg2Rm;t2 þet (4)

According to Chang et al. (2000), presence of significantly negative non-linear

coefficient γ2 confirm the existence of herding behavior, otherwise a statistically
positive γ2 indicates no evidence of herding. Gleason et al. (2004) argued that this
non-linear component would also be observed for CSSD if herding is present during
periods of market stress. To obtain a more comprehensive analysis, Gleason et al.
(2004) test two additional models where they swap the dependent variables in
Equations (2) and (4):

CSADt ¼ aþb U1 DtU þb L2 DLt þe t (5)

CSSD t ¼ aþg 1 . R m;t. þg2Rm;t2 þe t (6)

It is observed that rate of increase in dispersion with respect to aggregate market

returns is higher when market is progressing as compare to when market is declining.
The herding regression is estimated separately for positive and negative market
IJOEM returns to investigate the asymmetry in bullish and bearish trends. Specifically, the
10,3 system can be written as:
2
CSADUp ¼ at þgUp.RUp
1 þ gUpðRUp
. m; 2 m;Þ þet; if Rm;t 4 0 (7)
t t

480 CSADDown
t ¼ a þgDown.RDown.
1 m; 2 þ gDownðRDownÞ
m;
2
þ et; if Rm;t
o0 (8) t t

Up 2 Down 2
where Rm; Up m;
ðRDown Þ represent the equal-weighted portfolio returns during the bullish
(bearish) tmarkett trends at time t, and ðRm;t Þ [ðRm;t Þ ] is the squared value of equal-
weighted portfolio Utop investigate the non-linearity in market returns when market is rising
(declining). CSAD ðCSADDown Þ is the CSAD at time t consequent to rising (declining)
t t
market returns.
According to literature, it is observed that positive relationship exist between
market returns and trading volumes (Wermers, 1999; Nofsinger and Sias, 1999).
Where as Li et al. (2009) found positive correlation among average trading volumes
and market returns of the individual investors. This study also examines possible
asymmetric effects during periods of high or low volume. For daily returns trading
volume Vt is considered to be high (low) if on day t it is greater (lesser) then last 30
days moving averages. Similarly, for monthly data five months moving averages is
used. The herding regression is estimated separately for high and low trading
volumes. Specifically, this arrangement is represented as:
. Σ2
CSADVt —high ¼ a þg1V —high .Rm;
V —high
. þg2
V —high
Rm;V —high t (9)
þe t t

. Σ2
CSADVt —low ¼ aþ g1V —low .RV —low . þ g2 V —low RV —low t (10)
m; m;
þe t t

m; refers to market returns when trading volume is high and RV—low m;

t V— t
where R
represent the low trading volumes state. Significantly, negative coefficients γ2 establish
the presence of herding in market with respect to trading volumes.
This study examines the level of herding with respect to market volatility and
investigates potential asymmetric effects. Hellwig (1980) argued that information
asymmetry may drive volatility, irrational investor follow the market trends by buying
when prices rise and sell when prices fall so uninformed trading result in volatility, this
behavior is identical to herding. Therefore, increases volatility due to irrational trading
results may lead to herd formation. Similar to our analysis of trading volume, we
examine possible asymmetric effects during periods of high or low volatility. For daily
returns volatility δt is considered to be high (low) if on day t it is greater (lesser) then
last 30 days moving averages. Similarly, for monthly data five months moving averages
is used. The possible asymmetric effect is investigated using following empirical
specification:

CSADd ; High
2
. 2 Σ2
d2; High. d2; High. d2 ; H igh d ; H igh (11)
a g R . m;t g R þ et
t ¼þ 1 .þ m;t
2
CSADd ; Low . 2 Σ2
2

d2; Low. d2; Low. (12)

gd ; Low Rd ; Low þ e
2

t ¼a gþ 1
R.
m;t .þ m;t t
2
 ;High ; Low
where Rd2 refer to high-return volatility and Rd2 represents low-return volatility,
Examination
and m;t
m;t
d2
2
ðRm;t Þ is computed as the square of the portfolio market return in period t. of herding
To check the potential impact of macroeconomic variables this research includes behavior
Treasury bill rates (used as a proxy for interest rates), money supply and exchange rates to
the herding regression. These variables have potential impact on asset price as well.
Changes in interest rates impact the theoretical value of companies and their share, a 481
share’s
fair value is its projected future cash flows discounted to the present using the investor’s
required rate of return. If interest rates fall and everything else is held constant, share value
should rise and vice versa. Money supply is a measure of liquidity available to investors,
more liquidity indicate more investment and excessive demand of equity that ultimately
results in upward movement of nominal equity prices. Therefore, it is hypothesized that
stock returns are positively related to an increase in money supply in short run. An
increase in stock prices increases the demand of domestic assets that causes domestic
currency to appreciate. Similarly, depreciation in domestic currency increases the export of
a country making local firms more competitive, and raises their stock prices. Therefore, it
is observed that depreciation in home currency leads to variation in equity prices.
Few studies on Pakistani markets investigated the role of information related to
market fundamental. Hussain and Mahmood (1999) suggest that stock market is
inefficient with respect to money supply, Nishat and Mustafa (2002) find out significant
impact of money supply on stock returns in long run. They also examined the
relationship between stock prices and exchange rates and found that Pakistani stock
markets are inefficient with respect to exchange rates. Similarly, Hasan and Javed (2009)
observed significant impact of four monetary variables, namely money supply, inflation
rate, interest rates and exchange rates on the stock price movement for the period 1998-
2008. Monetary policy is used as a major tool to stabilize the Pakistani economy.
These fundamental monetary variables play significant role and found to affect the
equity market movement. Therefore, in order to find out the resultant CSAD due to
herding in the presence of macroeconomic variables or the degree of market volatility,
this study
includes three major monetary variables as macroeconomic fundamentals.
If Rm,t become statistically insignificant andm, R2 becomes insignificant and non-
linear in the presence of the above mentioned macroeconomic variables then changes
in the CSADt is expected to be due to these fundamentals rather then herding.
Therefore, these macroeconomic variables allow us to take into account the effect of
macroeconomic information while determining the level of herding through CSADt:
2
. .CSAD
t ¼ þ 1 a m;tg þR 2 m;t þ 1 ð g tR Þþ 2 ð y tTB
Þþ 3yð ER
t Þþy t M e
(13)
In order to check the robustness of the analysis, we examine the possible effect of
March 2005 financial crises on our results. On March 15, 2005, Karachi stock market
index shot of the record and closed at 10,300 points, the KSE-100 index started to
slump down on March 16, 2005 just after a week time on March 24, 2005, crash-landed
at 7,900 points. In this regard, data covering the period between 31 January and 29 April
was separated and following regression equation was estimated:

CSADt ¼ aþg1.Rm;t. þg2Rm;t2

2
þg3Rm;t ~ DM t þe t (14)
where DMt is dummy variable takes the value of unity during the crisis period, and zero
otherwise. In this study, cross dummy g3m;
R2 ~ DM t is used to capture the non-linearity
t
of returns during crisis.
IJOEM 5. Results and discussion
10,3 Descriptive statistics
Table I reports summary statistics for weighted average portfolio market returns, CSSD
and CSAD for daily and monthly data. The average monthly market returns are greater
than that of daily returns. As expected, the return dispersion measures increases with the
increase in time interval. The magnitude of dispersion measure is higher for the monthly
482 data than for daily data. Mean and variability is lower for daily CSAD measure as
compare to daily CSSD measure, which confirms the empirical findings of Granger and
Ding (1995).
Regression results for extreme market movements using CSSD
Table II provides the regression estimates for KSE-100 index companies during extreme
market movements. In this research 1 and 5 percent criteria is used to restrict the dummy
variables for the lower and upper tail of the market return distribution. For daily returns,
regression results yield significantly positive values for all coefficients indicating a
divergence of individual market returns from the aggregate market portfolio returns, in other
words absence of herding behavior supporting the assumption of the rational asset pricing.
According to rational asset pricing model individual securities, differ in their
sensitivity to the market return, therefore level of dispersion increases during period of
market stress. Whereas, due to herding this individual return dispersion from the
market
returns decreases (Christie and Huang, 1995).
The coefficients for monthly returns are significantly positive for 1 percent criteria
and insignificant for 5 percent criteria which indicates that information is averaged
out in long run. These results are consistent with Tan et al. (2008).
Regression results for extreme market movements using CSAD
Table III shows the result of extreme market movements using CSAD and report results
similar to CSSD, β1 and β2 coefficients are significantly positive indicating a divergence
of individual market returns from the aggregate market portfolio returns, in other words
absence of herding behavior. These results support the assumption of Gleason et al.
(2004) that irrespective of measure used for dispersion, market returns exhibit same
results.
According to Christie and Huang (1995), the presence of positively significant
coefficient supports the assumption of rational asset pricing model in extreme market
returns. Above results are similar to Table II except the adjusted R2 that become
progressively higher, and give more explanatory power to the model when CSAD is
used as a dependant variable instead of CSSD. In all two cases, CSAD provides a
better fit of data comparative to CSSD.

Regression results estimation of non-linearity using CSSD and CSAD

Table IV presents the regression results based on the Chang et al. (2000) model,
where quadratic term is included to evaluate the possibility of non-linearity to
change in

Sample Variable n Mean (%) SD (%) Min. (%) Max. (%)

Daily Rm,t 775 0.0808 1.0897 −5.5478 5.6408
CSSDt 775 2.5294 2.6631 1.0931 47.5412
CSADt 775 1.6395 0.6864 0.3690 11.0385
Table I. Monthly Rm,t 60 2.7153 6.6532 −17.3535 13.7407
Results of CSSDt 60 18.8997 15.7246 7.6236 69.5434
descriptive statistics CSADt 60 10.3578 3.9198 5.7265 22.8818
dispersion. For daily data, the coefficient γ1, is significant and negative confirming
that CSAD and CSSD both decreases with the absolute market returns, these findings Examination
depict inefficiency in market. of herding
Whereas the non-linear term γ2 is statistically significant but there is no evidence behavior
of herding because market dispersion is increasing at increasing rate showing
inefficiency in market rather then herding. These results suggest that investor’s trade
away from the market consensus during periods of market stress.
Above results were confirmed by adding continuous values of market returns to 483
the following equation:
2
. t ¼
.CSAD — 3:08 m;t þR
2:63 þet
m;t nn nn (15)
1:23R ð—12:07Þ ð20:57Þ

When the observations were plotted, it was observed that dispersion decreases with
the increase in market returns but this decrease in dispersion diminishes at a specific
point. After this dispersion of individual returns from market returns starts to increase
at an increasing rate. Therefore, when market start recovery the dispersion between
stock and return decreases and when market enters in profit zone and returns
increases

Sample α bU1 bL1 Adj. R2 F

Panel A: Using 5% criterion

Daily t-stats 2.3226 1.9454 1.7961 0.0472 (20.20)***
(23.48)*** (4.55)*** (4.58)***
Monthly t-stats 17.5010 14.2632 13.7116 0.0399 (2.2261)
(8.34)*** (1.56) (1.50)
Panel B: Using 1% criterion
Daily t-stats 2.3584 7.1122 9.4544 0.1977 (96.41)***
(27.23)*** (8.38)*** (11.15)*** Table II.
Monthly t-stats 17.2326 50.3415 49.6870 0.3080 (14.13)*** Regression
coefficients for
(10.03) (3.81)*** (3.76)***
Notes: ***Results are significant at 0.01 level CSSDt ¼ aþb U
1t D
U
L þ et
þb2L D t

Sample α bU1 bL1 Adj. R2 F

Panel A: Using 5% criterion

Daily t-stats 1.5380 1.0288 0.8199 0.1804 (86.20)***
(65.05)*** (10.06)*** (8.76)***
Monthly t-stats 9.9419 4.6388 3.6782 0.0731 (3.32)*
(19.35)*** (2.07)** (1.64)
Panel B: Using 1% criterion
Daily t-stats 1.5898 2.2908 2.5144 0.2465 (127.66)*** Table III.
(73.51)*** (10.81)*** (11.87)*** Regression
Monthly t-stats 9.964 12.9172 10.6764 0.2749 (12.188)*** coefficients for
(22.73)*** (3.83)*** (3.17)*** CSADt ¼ aþb1U DtU
LL
Notes: *,**,***Results are significant at 0.05, 0.01 and o0.01 level, respectively þb D2 þe
t t
IJOEM 10,3
Sample α γ1 γ2 Adj. R2 F
Panel A: Using CSSD
Daily t-stats (48.05)***
1.4632 (−1.51)
−0.0786 (13.88)***
0.1985 0.542 (459.33)***
Monthly t-stats 10.7101 −0.7317 0.07841 0.246 (10.66)***
484 (9.79)*** (−2.09)** (3.29)***
Panel B: Using CSAD
Daily t-stats 3.0833 −2.6297 1.2303 0.4679 (341.44)***
Table IV. (24.21)*** (−12.07)*** (20.57)***
Regression results Monthly t-stats 25.2567 −4.1614 0.3604 0.2017 (8.45)***
estimation of (5.59)*** (−2.88)*** (3.66)***
non-linearity Notes: **,***Results are significant at 0.05 and 0.01 level, respectively

CSAD also increases, it means their exist divergence between market returns and
individual stock returns. It means it means dispersion follows a parabolic path. These
results are not unique in Pakistan and observed in other emerging and developed
markets too. Demirer et al. (2007) observed such behavior in African market.
Therefore, it can be concluded that herding does not exist in Pakistani stock market.
However, results are also inconsistent with the assumption of rational asset pricing
model and indicates divergent behavior under different states which may be attributed
to inefficiency of market.
Monthly returns provide similar results and it is suggested that assets are mispriced
in Pakistani stock market as market is driven by speculative sentiments. Due to
asymmetry of information to traders, uncertainty in market trends and poorly
regulated market structure, the prevailing sentiments of speculative and insider
trading have been controlling the market. This inefficiency in market behavior often
resulted in price volatility and as well as price manipulation. The presence of short-
term speculators also affects the pricing mechanism. Results in Panel B support the
findings of Gleason et al. (2004), by swapping CSAD with CSSD there was no
difference in results. Market exhibit same behavior irrespective of measure utilized.
Asymmetric effect of herding behavior
Market returns. Table V reports the evidence of herding behavior during bull and bear
conditions, absolute returns are used because we are interested in the size of returns not
the signs. Panel A reports that γ1 coefficients for up market returns are insignificant for
both daily and monthly returns, whereas γ2 coefficients are significant and positive. At
the beginning dispersion between individual returns and market returns decreases,
immediately after reaching a specific point the crowding of returns disappear and
prices continuously move due to inefficiency and mispricing.
As shown in above table during period of falling market returns the γ1 coefficient
are insignificant for both daily and monthly market returns violating the assumption of
asset pricing model, whereas γ2 coefficient are significant and positive. Both models
are overall good fit as the F-test give significant results. The explanatory power is
almost same in both bull and bear market conditions. When returns increases in bull
market, dispersion reduces and when loss increases in bearish market dispersion
increase.
Trading volume. Panels A and B of Table VI reports the results of the asymmetric
trading volume herding regressions. Trading volume is another indicator that capture useful
Panel A: Bull market conditions (R m,tW 0) Up
Examination
Sample α g
1
Up
Adj. R2 of herding
g F
Daily t-stats 1.4868 −0.1058 0.2153
2 0.5426 (280.45)*** behavior
(40.69)*** (−1.64) (12.10)***
Monthly t-stats 9.3521 −0.2393 0.0425 0.1303 (3.92)**
(6.83)*** (−0.51) (1.24)
Panel B: Bear market conditions (Rm,t o0)
Sample α g1Down
485
Dow
Adj. R2 F
gn2
Daily t-stats 1.4223 −0.0377 0.1816 0.5428 (180.34)*** Table V.
(26.78)*** (−0.43) (7.68)*** Estimating
Monthly t-stats 11.9925 −1.1119 0.1026 0.3304 (5.68)*** regression in bull
(5.82)*** (−1.65) (2.56)** and bear market
Notes: **,***Results are significant at 0.05 and 0.01 level, respectively conditions

Panel A: High trading volume state

Sample α g1V—high Adj. R2 F
gV2 —
high
Daily t-stats 1.3699 0.3897 −0.0128 0.2644 (65.72)***
(37.15)*** (4.75)*** (−0.36)
Monthly t-stats 11.9954 −1.0412 0.0921 0.3641 (9.02)***
(7.22)*** (−2.18)** (3.13)***
Panel B: Low trading volume
state
Sample α gV—low gV2 — Adj. R2 F
1
low
Daily t-stats 1.4556 −0.1997 0.2290 0.6080 (298.85)*** Table VI.
(30.62)*** (−2.56)** (11.64)*** Estimating
Monthly t-stats 10.4362 −0.8300 0.1005 0.0300 (1.40) regression in high
(5.80)*** (−1.05) (1.39) and low trading
Notes: **,***Results are significant at 0.05 and 0.01 level, respectively volume state

information from different facet. Trading volume may could be low when price swings are
high and vice versa. Therefore, in study of herding behavior, a large price swing may be
possible condition. However, a high level of trading volume is a necessary condition for
herd formation behavior among investors as it is outcome of a voluntarily synchronized act.
The evidence from Panel “A” indicates that in the high trading volume state γ1 coefficient
are significant and positive, confirming the assumption of asset pricing model, whereas γ2
measure is insignificant indicating no herding during period of high trading volumes.
These results indicate that Pakistani markets are weak form efficient when trading
volumes are high, whereas these affects vanishes as the time horizon expands in case
of monthly data. Husain and Frobes (1999) investigated weak form efficiency in
Pakistani stock market and stated that Pakistani stock market adjusted slowly to the
new information.
According to Table VI the coefficient γ2 is positive and significant for all daily
returns, when trading volume is low, thus confirming increase in dispersion from market
returns with no evidence of herding. However, the presence of statistically negative
1
gV—low is
indicative of relative inefficiency and negate the assumption of rational asset pricing
model. The coefficient 2gV—low is insignificant for monthly data, showing no herding as
the
time interval increases.
IJOEM Market volatility. This study found similar results when market volatility was high.
10,3 For daily returns volatility,1 gd—high coefficient was negative and significant showing
decrease in dispersion from market returns and relative inefficiency. Whereas, g2 d—high
found significant and positive depicting increase in dispersion of individual returns
from average market returns. Hence, no herding when returns volatility was high
486 (Table VII). It is argued that in efficient markets volatility of stock returns is
affected by the
volatility of variables that affect asset prices, whereas in informational inefficient
markets, markets are adjusted slowly to the new information. Therefore, investors are
reluctant to choose optimal investments (Husain and Frobes, 1999). They usually
withdraw their existing funds and reluctant to invest for a longer period due to lack of
informational inefficiencies. In such a realm government frequent interventions and
weak and less-developed market structure creates uncertainty and inefficiency
especially in case of developing or emerging economies.
During period of low market returns volatility, both γ1 and γ2 coefficients are
insignificant for daily and monthly returns. Therefore, no herding when market return
volatility is low. These results are consistent with Tan et al. (2008).
Herding behavior and macroeconomic fundamental. This study also explored the
effect of change in macroeconomic information on the presence of herd formation.
According to Table VIII, the effect of macroeconomic fundamentals on herding
behavior is insignificant, therefore confirming the state of inefficiency in markets.
According to Kutan and Yuan (2005) market activity in emerging markets is
more significantly affected by the political news than macroeconomic news. Similarly,
Morck et al. (2000) stated that the emerging stock markets process economic information
less usefully than stock markets in advance economies. Therefore, according to results,
it is stated that the Pakistani markets is less responsive to the macroeconomic
fundamentals, therefore investor behavior remain unaffected by the macroeconomic
fundamental news.

Panel A: High-volatility
state d2;High d2;High Adj. R2
Sample α g1 g2 F
Daily t-stats 12.5091 −24.1715 13.0754 0.07222 (23.42)***
(4.22)*** (−3.93)*** (4.15)***
Monthly t-stats 20.0055 −3.6029 0.2948 0.2821 (6.69)***
(4.43)*** (2.64)** (3.12)***
Panel B: Low-volatility state d2;Low d2;Low Adj. R2
Sample α g1 g2 F
Table VII. Daily t-stats 1.5070 −0.7263 0.8128 0.0433 (4.78)***
Estimating (0.51) (−0.12) (0.25)
regression in high- Monthly t-stats 14.1342 −1.7981 0.1553 0.1685 (3.43)**
and low-volatility (4.54)*** (−1.74) (2.14)**
state Notes: **,***Results are significant at 0.05 and 0.01 level, respectively

Table VIII.
Regression results to Sample α γ1 γ2 θ3 θ4 θ5 Adj. R2 F Sig.
detect the affect of
Monthly t-stats −360.28 4.3276 0.3481 17.0354 21,611.4 0.0079 0.228 4.493 0.0017
macroeconomic
−1.38 (−3.01)*** (3.57)*** 0.0088 1.4616 1.6073
fundamentals
Notes: ***Results are significant at 0.01 level
Robustness of the herding measure. In order to check the robustness of the results,
cross dummies are used for the separated data set of March 2005 stock market Examination
crisis. The presence of significant negative γ3 coefficient confirms the presence of of herding
herding during period of extreme market movements, specifically when market behavior
follows bullish trends (Table IX).
Therefore, it is observed that in the long run herding is not evident but it is present
when returns are highly volatile. It may be due to asymmetry of information among
investors and presence of speculator who were dominating the market during that
487
volatile period. It also led to the government intervention and ban on badla financing
as local leverage financing mechanism. Overall market trading activities are
indicative of inefficiency driven by unidentified trading pattern. These findings are
similar with Caporale et al. (2008) where herding was observed in Portuguese stock
market during crisis period.

6. Conclusion
This study investigates the existence of herding behavior in Pakistani stock markets.
The analysis of daily and monthly return provides no evidence of investor herding.
The empirical results indicate that during periods of extreme price movements,
equity return dispersions tend to increase rather than decrease, hence providing
evidence against herd behavior. This study shows results consistent with those
documented by Christie and Huang (1995) and support the assumption of the rational
asset pricing model indicating the efficiency of markets during extreme market
movements. Similarly, results based on Chang et al. (2000) model confirm no herding
during extreme market movements. These results support the Gleason et al. (2004)
argument that measure of dispersion used is relevant as market returns exhibit same
behavior for different proxies.
The possibility of non-linearity of relationship is also explored by using Chang et
al. (2000) model and quadratic term is found significantly positively measure of
dispersion According to Chang et al. (2000), presence of significantly negative non-
linear coefficient confirm the existence of herding behavior, otherwise a statistically
positive indicates no evidence of herding. Therefore, it may be safely said that no
herding is observed in Pakistani stock market. It is further added that dispersion
increase during negative returns period and decreases during high-return periods.
In addition, potential asymmetric effect related to market returns, trading volume
and market volatility is also examined. During bull and bear conditions, market
returns are insignificantly related to measure of dispersion for both daily and monthly
returns whereas non-linear term is significantly and positively related to measure of
dispersion. It indicates absence of herding in Pakistani market in bullish or bearish
trends. At the beginning dispersion between individual returns and market returns
decreases, immediately after reaching a specific point the crowding of returns
disappear and inefficiency is observed.

Sample α γ1 γ2 γ3 Adj. R2 F Sig.

Table IX.
Daily 1.4613 −0.0916 0.2238 −0.0745 0.5640 334.7883 0.0000 Regression results to
t-stats 49.1727 −1.8033 15.4137 −6.2985 check the robustness
p-value 0.0000 0.0717 0.0000 0.0000 of herding measure
IJOEM Similarly, in both low and high trading volume state, no evidence of herding is
10,3 observed. However, in high-volume state, analysis on daily data shows results consistent
with the rational asset pricing model. Similar pattern are observed during high- and
low-volatility period. Therefore, it may be said that Pakistani markets are weak form
efficient particularly when trading volume are high. When macroeconomic factors were
included in the model, it was observed that macroeconomic information have
488 insignificant role in the decision-making process of market participants.
Lastly, the study examines crises period of March 2005, to find out the impact of
abnormal nature of stock market on investor’s trading activities. These results alter
our evidence in favor of herding specifically in stock market crises and have
important implications for stock market inefficiency, offering an interesting insight to
detect the presence of herding behavior during stock market crises. Therefore, this
model can be used to detect herd behavior in Pakistani markets.
This study has further implication for investors. It facilitates in identification of
potential risks and guides in devising appropriate strategy for investment in Karachi stock
market. As the assets are mispriced, investor behavior is uncertain and markets
are inefficient, foreign investors should invest with caution, as large numbers of securities
are required to achieve the same level of diversification than in an otherwise normal
market. Similarly, for an accurate valuation of assets investors should consider the role
the herding factor at a particular point of time. In future, a study can be conducted by
employing stock returns portfolios based on market capitalization or sector wise portfolio
returns from KSE-100. Furthermore, such factors can be identified that define the pattern
of the investor trading activities and make the market inefficient.

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