HERD ON ThE STREET:
INFORMATIONAL INEFFICIENCIES IN A MARKET WITH SHORT-TERM SPECULATION

Kenneth A. Froot
David S. Scharfstein
Jeremy C. Stein
Working Paper No. 3250
NATIONAL BUREAU OF ECONOMIC RESEARCH
1050 Maasachusetts Avenue
Cambridge, MA 02138
February 1990

A3STRACT
Standard models of informed speculation suggest that traders try to learn infor-
mation that others do not have. This result implicitly relies on the assumption
that speculators have long horizons, i.e, can hold the asset forever. By contrast,
we show that if speculators have short horizons, they may herd on the same in-
formation, trying to learn what other informed traders also know. There can be
multiple herding equilibria, and herding speculators may even choose to study
information that is completely unrelated to fundamentals. These equilibria are
informationally inefficient.

HerdBehaviorandInvestment:Comment
By MarcoOttavianiandPeterSørensen∗
November1999.Forthcoming,AmericanEconomicReview
Inaninfluentialpaper,DavidS.ScharfsteinandJeremyC.Stein(1990)modeled
sequentialinvestmentbyagentsconcernedabouttheirreputationasgoodforecasters.
Consideranagentwhoactsafterobservingthebehaviorofanotherex-anteidentical
agent.ScharfsteinandSteinarguethat reputationalherding requiresthatbetteragents
havemore correlated signalsconditionallyonthestateoftheworld.Theyclaimthat
withoutcorrelationthesecondagentwouldhavenoincentivetoattempttomanipulate
themarketinferenceaboutabilitybyimitatingthebehaviorofthefirstagent.Inthis
noteweshowthatintheirmodelcorrelationisnotnecessaryforherding,otherthanin
degeneratecases.