Do Investors Mimic Trading Strategies of Foreign Investors or the Market: Implications for Capital Asset Pricing

W. Chamil Senarathne 1  and Wei Jianguo 1
  • 1 Wuhan University of Technology,, Wuhan, China


This paper examines the presence of herding on foreign trading at individual stock level and portfolio level in the Colombo Stock Exchange as a response to a long-standing trading belief that investors mimic the trading strategies of foreign investors. The standard CSAD framework of Chang et al (2000) is extended replacing return on market portfolio with return on market foreign portfolio holding in the model specification. The standard CSAD specification is also used to identify the presence of herding towards the market under high market volatility, bullish market condition, high trading and transaction volume, domestic and global market crisis and up and down market conditions. Except for the evidence on herding towards the market under bullish market condition at portfolio level, the regression results under other market conditions do not provide reasonable evidence for the presence of herding on foreign trading or herding towards the market on average. Further, taking CSAD as a proxy for heteroskedastic residuals following the framework of Banz (1981), the capital asset pricing model of Black (1972) is used to test the specification of CSAD. The findings suggest that the form of herding accounted for by CSAD is a manifestation of residual heteroskedasticity.

If the inline PDF is not rendering correctly, you can download the PDF file here.

  • Babalos, V., Balcilar, M., Gupta, R. (2015), Herding behavior in real estate markets: novel evidence from a Markov-switching model, Journal of Behavioral and Experimental Finance, Vol. 8, no. 1, pp. 40-43

  • Bachelier, L. (2011), Louis Bachelier's theory of speculation: the origins of modern finance. Princeton University Press.

  • Balcilar, M., Demirer, R., Hammoudeh, S. (2014), What drives herding in oil-rich, developing stock markets? Relative roles of own volatility and global factors, The North American Journal of Economics and Finance, Vol. 29, pp. 418-440.

  • Banz, R. W. (1981), The relationship between return and market value of common stocks, Journal of Financial Economics, Vol. 9, no. 1, pp. 3-18.

  • Bekiros, S., Jlassi, M., Lucey, B., Naoui, K., Uddin, G. S. (2017), Herding behavior, market sentiment and volatility: Will the bubble resume?, The North American Journal of Economics and Finance, Vol. 42, pp. 107-131.

  • BenSaïda A. (2017), Herding effect on idiosyncratic volatility in US industries. Finance Research Letters, Vol. 23, pp. 121-132.

  • Black, F. (1972), Capital market equilibrium with restricted borrowing, The Journal of Business, Vol 45, no. 3, pp. 444-455.

  • Blasco, N., Corredor, P., Ferreruela, S. (2012), Does herding affect volatility? Implications for the Spanish stock market, Quantitative Finance, Vol. 12, no. 2, pp. 311-327.

  • Bohn, H., Tesar, L. (1996), U.S. equity investment in foreign markets: portfolio rebalancing or return chasing?, American Economic Review, Vol. 86, no. 2, pp. 77-81.

  • Bowe, M., Domuta, D. (2004), Investor herding during financial crisis: A clinical study of the Jakarta Stock Exchange, Pacific-Basin Finance Journal, Vol. 12, no. 4, pp. 387-418.

  • Brennan, M.J., Cao, H.H. (1997), International portfolio investment fows, The Journal of Finance, Vol. 52, no.5, pp. 1851-1880.

  • Breusch, T. S., Pagan, A. R. (1979), A simple test for heteroscedasticity and random coefficient variation, Econometrica, Vol. 46, no. 5, pp. 1287-1294.

  • Chang, E. C., Cheng, J. W., Khorana, A. (2000), An examination of herd behavior in equity markets: An international perspective, Journal of Banking and Finance, Vol. 24, no. 10, pp. 1651-1679.

  • Choe, H., Kho, B. C., Stulz, R. M. (1999), Do foreign investors destabilize stock markets? The Korean experience in 1997, Journal of Financial Economics, Vol. 54, no. 2, pp. 227-264.

  • Christie, W. G., Huang, R. D. (1995), Following the pied piper: Do individual returns herd around the market?, Financial Analysts Journal, Vol. 51, no. 4, pp. 31-37.

  • Chuang, W. I., Lee, B. S., (2006), An Empirical Evaluation of the Overconfidence Hypothesis, Journal of Banking and Finance, Vol. 30, no. 9, pp. 2489-2515.

  • Chung, C. Y., Kim, H., Ryu, D. (2017), Foreign investor trading and information asymmetry: Evidence from a leading emerging market, Applied Economics Letters, Vol. 24, no. 8, pp. 540-544.

  • Clark, J., Berko, E. (1997), Foreign investment fluctuations and emerging market stock returns: The case of Mexico, Federal Reserve Bank of New York.

  • Clark, P. K. (1973), A subordinated stochastic process model with finite variance for speculative prices, Econometrica, Vol. 41, no. 1, pp. 135-155.

  • Dennis, P. J., Strickland, D. (2002), Who blinks in volatile markets, individuals or institutions?, The Journal of Finance, Vol. 57, no. 5, pp. 1923-1949.

  • Dornbusch, R., Park, Y. C. (1995), Financial integration in a second-best world: are we still sure about our classical prejudices, In: Dornbusch, R., Park, Y.C. (Eds.), Financial Opening: Policy Lessons

  • Economou, F., Kostakis, A., Philippas, N. (2011), Cross-country effects in herding behaviour: Evidence from four south European markets, Journal of International Financial Markets, Institutions and Money, Vol. 21, no. 3, pp. 443-460.

  • Engle, R. F. (1982), Autoregressive conditional heteroscedasticity with estimates of the variance of United Kingdom inflation, Econometrica, Vol. 50, no. 4, pp. 987-1007.

  • Epps, T. W., Epps, M. L. (1976), The stochastic dependence of security price changes and transaction volumes: Implications for the mixture-of-distributions hypothesis, Econometrica, Vol. 44, no. 2, pp. 305-321.

  • Fama, E. F. (1965), The behavior of stock-market prices, The Journal of Business, Vol. 38, no. 1, pp. 34-105.

  • Fama, E. F. (1970), Efficient capital markets: A review of theory and empirical work, The Journal of Finance, Vol. 25, no. 2, pp. 383-417. for Korea, Korea Institute of Finance, Seoul, Korea.

  • Gabaix, X., Gopikrishnan, P., Plerou, V., Stanley, H. E. (2006), Institutional investors and stock market volatility. The Quarterly Journal of Economics, Vol. 121, no. 2, pp. 461-504.

  • Grinblatt, M., Titman, S., Wermers, R. (1995), Momentum investment strategies, portfolio performance, and herding: A study of mutual fund behavior. The American Economic Review, Vol. 85, no.5, pp. 1088-1105.

  • Harris L (1987), Transaction data tests of the mixture of distributions hypothesis, Journal of Financial and Quantitative Analysis, Vol. 22, no. 2, pp. 127-141.

  • Henker, J., Henker, T., Mitsios, A. (2006), Do investors herd intraday in Australian equities?, International Journal of Managerial Finance, Vol. 2, no. 3, pp. 196-219.

  • Holmes, P., Kallinterakis, V., Ferreira, M. P., (2013), Herding in a Concentrated Market: a Question of Intent, European Financial Management, Vol. 19, no. 3, pp. 497-520.

  • Houda, B. M., Mohamed, F. (2013), Herding during market upturns and downturns: International evidence, IUP Journal of Applied Finance, Vol. 19, no. 2, pp. 5-26.

  • Huang, T. C., Lin, B. H., Yang, T. H. (2015), Herd behavior and idiosyncratic volatility, Journal of Business Research, Vol. 68, no. 4, pp. 763-770.

  • Hwang, S., Salmon, M. (2004), Market stress and herding, Journal of Empirical Finance, Vol. 11, no. 4, pp. 585-616.

  • Iihara, Y., Kato, H., Tokunaga, T. (2016), Investors’ Herding on the Tokyo Stock Exchange, Behavioral Economics of Preferences, Choices, and Happiness, pp. 639-666.

  • Jovanovic, F., Le Gall, P. (2001), Does God practice a random walk? The'financial physics' of a nineteenth-century forerunner, Jules Regnault, European Journal of the History of Economic Thought, Vol. 8, no. 3, pp. 332-362.

  • Kadirgamar, A. (2012), Stock Market Crisis And Oligarchic Interests, Colombo Telegraph, August, available at

  • Karpoff, J. M. (1986), A theory of trading volume, The Journal of Finance, Vol. 41, no. 5, pp. 1069-1087.

  • Kremer, S., Nautz, D. (2013), Causes and consequences of short-term institutional herding, Journal of Banking and Finance, Vol. 37, no. 5, pp. 1676-1686.

  • Lakonishok, J., Shleifer, A., Vishny, R. W. (1992), The impact of institutional trading on stock prices, Journal of Financial Economics, Vol. 32, no. 1, pp. 23-43.

  • Lamoureux, C. G., Lastrapes, W. D. (1990), Heteroskedasticity in stock return data: volume versus GARCH effects, The Journal of Finance, Vol 45, no. 1, pp. 221-229.

  • Litimi, H., BenSaïda, A., Bouraoui, O, (2016), Herding and excessive risk in the American stock market: A sectoral analysis, Research in International Business and Finance, Vol 38, pp. 6-21.

  • Majand, M., Yung, K. (1991), A GARCH examination of the relationship between volume and price variability in futures markets, Journal of Futures Markets, Vol 11, no. pp 5, pp. 613-621.

  • Mandelbrot, B. (1963), The variation of certain speculative prices, The Journal of Business, Vol. 36, no. 4, 394-419.

  • Nelson, D. B. (1991), Conditional heteroskedasticity in asset returns: A new approach, Econometrica, Vol. 59, pp. 347-370.

  • Newey, W.K., West, K.D. (1987), A simple positive semi-definite heteroscedasticity and autocorrelation consistent covariance matrix, Econometrica, Vol. 55, pp. 703-708.

  • Nofsinger, J. R., Sias, R. W. (1999), Herding and feedback trading by institutional and individual investors, Journal of Finance, Vol. 54, no. 6, pp. 2263-2295.

  • Ouarda, M., El Bouri, A., Bernard, O. (2013), Herding behavior under markets condition: Empirical evidence on the European financial markets, International Journal of Economics and Financial Issues, Vol. 3, no. 1, pp. 214-228

  • Philippas, N., Economou, F., Babalos, V., Kostakis, A. (2013), Herding behavior in REITs: Novel tests and the role of financial crisis, International Review of Financial Analysis, Vol. 29, pp. 166-174.

  • Reuters (2011), Stock market crashes to lowest level in 2011, Daily Financial Times, October, available online at http:/

  • Reuters (2017), Stock market up for ninth straight session on foreign buying, Daily Financial Times, April, available online at

  • Reuters (2017), Stock market up on foreign buying, hit more than 3-week closing high, Daily Financial Times, March, available onine at

  • Satish Kumar, (2017), Revisiting the price-volume relationship: a cross-currency evidence, International Journal of Managerial Finance, Vol 13, no. 1, pp. 91-104.

  • Schuppli, M., Bohl, M. T. (2010), Do foreign institutional investors destabilize China’s A-share markets?, Journal of International Financial Markets, Institutions and Money, Vol. 20, no. 1, pp. 36-50.

  • Senarathne, C. W., Jayasinghe, P. (2017), Information Flow Interpretation of Heteroskedasticity for Capital Asset Pricing: An Expectation-based View of Risk, Economic Issues, Vol. 22, no. 1, pp. 1-24.

  • Sewwandi, W.G.T. (2016), Herding in Colombo Stock Exchange, EPRA International Journal of Multidisciplinary Research, Vol. 2, no. 3, pp. 182-186.

  • Sharpe, W. F. (1964), Capital asset prices: A theory of market equilibrium under conditions of risk, The Journal of Finance, Vol. 19, no. 3, pp. 425-442.

  • Shleifer, A. (2000). Inefficient markets: An introduction to behavioural finance, New York; Oxford University Press.

  • Tan, L., Chiang, T. C., Mason, J. R., Nelling, E. (2008), Herding Behavior in Chinese Stock Markets: an Examination of A and B Shares, Pacific-Basin Finance Journal, Vol 16, no 1, pp. 61- 77.

  • Tauchen, G. E., Pitts, M. (1983), The price variability-volume relationship on speculative markets, Econometrica, Vol 51, no. 2, pp. 485-505.

  • Tesar, L.L., Werner, I.M., (1995), Home bias and high turnover, Journal of International Money and Finance, Vol. 14, pp. 467-492.

  • Venezia, I., Nashikkar, A., Shapira, Z. (2011), Firm specific and macro herding by professional and amateur investors and their effects on market volatility, Journal of Banking and Finance, Vol. 35, no. 7, pp. 1599-1609.

  • Wan, D., Yang, X. (2017), High Frequency Positive Feedback Trading and Market Quality: Evidence from China's Stock Market, International Review of Finance, Vol. 17, no. 4, pp 493-523.

  • Wermers, R. (1999), Mutual fund herding and the impact on stock prices, Journal of Finance, Vol 54, no. 2, pp. 581-622.

  • White, H. (1980), Heteroskedasticity constant variance matrix estimator and a direct test of heteroskedasticity, Econometrica, Vol. 48, no. 4, pp. 817-818.

  • Xie, T., Xu, Y., Zhang, X., (2015), A new method of measuring herding in stock market and its empirical results in Chinese A-share market, International Review of Economics and Finance, Vol. 37, pp. 324-339.

  • Yao, J., Ma, C., He, W. P., (2014), Investor Herding Behaviour of Chinese Stock Market. International Review of Economics and Finance, Vol 29, no. 1, pp. 12-29.


Journal + Issues