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Hedge Funds: Herding among Instituional Market Participants

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Define Herding and discuss about the concept of Herding among Institutional Market Participants.
Solution
Devenow and Welch (1996) note in their herding literature review, that herding is generally defined as “behaviour patterns, which are correlated across individuals”. They propose another notion of herding which is “systematic erroneous decision-making by entire populations”.

Investor choice of money manager is often based on past performance appraisal. Comparing them to competitors’ results usually performs an evaluation of historical returns. Since investors look at returns on a comparative basis, investment managers could have a natural tendency to pursue similar strategies in order to preserve their reputation. The solution discusses about this Herding among participants in detail.
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