The Reserve Bank of India (RBI) has found that investors follow a herd mentality while investing in mid-cap stocks without considering any fundamentals or implying greater individual decision making.

“Though herding was not found for the other categories, we did find evidence of non-linear association between CSAD (cross sectional absolute deviation) and market returns for large-cap and small-cap stocks, implying greater individual decision making,” revealed an RBI study.

Interestingly, herding behaviour was more prominent when market returns are negative and foreign investors pull out money, said the report. The study was conducted between January 2019 and March 2020.

Volatility differs

The volatility greatly differs across periods with the market-down and net negative foreign equity investments (FEIs) causing a higher degree of volatility, indicating that negative news impacts the market to a greater degree.

The presence of herding activity questions the validity of the fact that all investors have the same information and predict the stock price similarly. Herding is a process in which investors in the market trade in the same direction, mimicking the decisions and actions of other investors, without paying much attention to their own beliefs or information.

The herding activity disrupts market movements by shifting the value of securities away from their fundamental value, said RBI.

Large-caps are volatile

It was observed that the median value of daily returns is the highest for large-cap stocks followed by mid-cap and small-cap stocks during the period of study. It suggests that large-cap stocks, on an average, performed better than the other two groups. However, the volatility in large-cap stocks was very high and was close to that of the Nifty index, the study revealed.

The skewness of returns of small-cap was positive while it was negative for other groups. “The dispersion trend fits well with the hypothesis of information asymmetry, as large-cap stocks tend to have greater coverage and availability of data, and therefore, greater dispersion from the mean,” said the study.

Understanding market growth

Testing herding behaviour across these three stated categories will be useful in identifying information asymmetries in the stock market, which is considered as the oldest, fast-growing and one of the most vibrant markets in Asia, the RBI said.

Examining the herd behaviour in the Indian stock market will help regulators and policymakers to understand market efficiency and growth, it added.

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