Herd Behavior in Financial Markets: An Experiment with Financial Market Professionals

We study herd behavior in a laboratory financial market with financial market professionals. An important novelty of the experimental design is the use of a strategy-like method. This allows us to detect herd behavior directly by observing subjects’ decisions for all realizations of their private signal. In the paper, we compare two treatments: one in which the price adjusts to the order flow in such a way that herding should never occur, and one in which the presence of event uncertainty makes herding possible. In the first treatment, subjects herd seldom, in accordance with both the theory and previous experimental evidence on student subjects. A proportion of sub jects, however, engage in contrarianism, something not accounted for by the theory. In the second treatment, the proportion of herding decisions increases, but not as much as the theory would suggest. Moreover, contrarianism disappears altogether. In both treatments, in contrast with what theory predicts, subjects sometimes prefer to abstain from trading, which affects the process of price discovery negatively.