Herding and Contrarian Behavior in Financial Markets - An Internet Experiment

We report results of an internet experiment designed to test the theory of informational cascades in financial markets. More than 6000 subjects, including a subsample of 267 consultants from an international consulting firm, participated in the experiment. As predicted by theory, we find that the presence of a flexible market price prevents herding. However, the presence of contrarian behavior, which can (partly) be rationalized via error models, distorts prices, and even after 20 decisions convergence to the fundamental value is rare. We also study the effects of transaction costs and the expectations of subjects with respect to future prices. Finally, we look at the behavior of various subsamples of our heterogeneous subject poolHerding, informational cascades, contrarian behavior, internet experiment

Funding liquidity risk: definition and measurement

In this paper we propose definitions of funding liquidity and funding liquidity risk and present a simple, yet intuitive, measure of funding liquidity risk based on data from open market operations. Our empirical analysis uses a unique data set of 135 main refinancing operation auctions conducted at the ECB between June 2005 and December 2007. We find that our proxies for funding liquidity risk are typically stable and low, with occasional spikes, especially during the recent turmoil. We are also able to document downward spirals between funding liquidity risk and market liquidity. JEL Classification: E58, G21bidding data, funding liquidity, Interbank markets, liquidity risk, money market auctions

Towards an Operational Framework for Financial Stability: "Fuzzy" Measurement and its Consequences

Over the last decade or so, addressing financial instability has become a policy priority. Despite the efforts made, policymakers are still a long way from developing a satisfactory operational framework. A major challenge complicating this task is the “fuzziness” with which financial (in)stability can be measured. We review the available measurement methodologies and point out several weaknesses. In particular, we caution against heavy reliance on the current generation of macro stress tests, arguing that they can lull policymakers into a false sense of security. Nonetheless, we argue that the “fuzziness” in measurement does not prevent further progress towards an operational framework, as long as it is appropriately accounted for. Crucial features of that framework include: strengthening the macroprudential orientation of financial regulation and supervision; addressing more systematically the procyclicality of the financial system; relying as far as possible on automatic stabilizers rather than discretion, thereby lessening the burden on the real-time measurement of financial stability risks; and setting up institutional arrangements that leverage the comparative expertise of the various authorities involved in safeguarding financial stability, not least financial supervisors and central banks.

An economic capital model integrating credit and interest rate risk in the banking book

Banks typically determine their capital levels by separately analysing credit and interest rate risk, but the interaction between the two is significant and potentially complex. We develop an integrated economic capital model for a banking book where all exposures are held to maturity. Our simulations show that capital is mismeasured if risk interdependencies are ignored: adding up economic capital against credit and interest rate risk derived separately provides an upper bound relative to the integrated capital level. The magnitude of the difference depends on the structure of the balance sheet and on the repricing characteristics of assets and liabilities. JEL Classification: G21, E47, C13asset and liability management, Credit risk, Economic capital, interest rate risk, risk management

Herding with and without Payoff Externalities - An Internet Experiment

Most real world situations that are susceptible to herding are also characterized by direct payoff externalities. Yet, the bulk of the theoretical and experimental literature on herding has focused on pure informational externalities. In this paper we experi- mentally investigate the effects of several different forms of payoff externalities (e.g., network effects, first-mover advantage, etc.) in a standard information-based herding model. Our results are based on an internet experiment with more than 6000 subjects, including a subsample of 267 consultants from an international consulting firm. We also replicate and review earlier cascade experiments. Finally, we study reputation e¤ects (i.e., the influence of success models) in the context of herding.information cascades, herding, network e¤ects, experiment, internet.

Herding with and without Payoff Externalities - An Internet Experiment

Most real world situations which are susceptible to herding are also characterized by direct payoff externalities. Yet, the bulk of the theoretical and experimental literature focuses on pure informational externalities. In this paper we study several different forms of payoff externalities that interact with a standard herding model. More than 6000 subjects, including a subsample of 267 consultants from an international consulting firm, participated in an internet experiment. We also replicate and review earlier cascade experiments. Finally, we study reputation effects in the context of herding.information cascades, herding, network effects, experiment, internet

Integrating credit and interest rate risk: A theoretical framework and an application to banks' balance sheets

Credit and interest rate risk in the banking book are the two most important risks faced by commercial banks. In this paper we derive a consistent and general framework to measure the riskiness of a bank which is subject to correlated interest rate and credit risk. The framework accounts for all sources of credit risk, interest rate risk and their combined impact As we model the whole balance sheet of a bank the framework not only enables us to assess the impact of credit and interest rate risk on the bank's economic value but also on its future earnings and capital adequacy. We apply our framework to a hypothetical bank in normal and stressed conditions. The simulation highlights that it is fundamental to measure the impact of correlated interest rate and credit risk jointly on the whole portfolio of banks, including assets, liabilities and off-balance sheet itemsIntegration of credit risk & interest rate risk, asset & liability management of banks, economic value, stress testing

Herding and Contrarian Behavior in Financial Markets - An Internet Experiment

We report results of an internet experiment designed to test the theory of informational cascades in financial markets. More than 6000 subjects, including a subsample of 267 consultants from an international consulting firm, participated in the experiment. As predicted by theory, we find that the presence of a flexible market price prevents herding. However, the presence of contrarian behavior, which can (partly) be rationalized via error models, distorts prices, and even after 20 decisions convergence to the fundamental value is rare. We also study the effects of transaction costs and the expectations of subjects with respect to future prices. Finally, we look at the behavior of various subsamples of our heterogeneous subject pool.herd behavior, informational cascades, contrarian investors, market efficiency, internet experiment

Herding and Contrarian Behavior in Financial Markets - An Internet Experiment

Lecture on the first SFB/TR 15 meeting, Gummersbach, July, 18 - 20, 2004We report results of an internet experiment designed to test the theory of informational cascades in financial markets (Avery and Zemsky, AER, 1998). More than 6400 subjects, including a subsample of 267 consultants from an international consulting firm, participated in the experiment. As predicted by theory, we find that the presence of a flexible market price prevents herding. However, the presence of contrarian behavior, which can (partly) be rationalized via error models, distorts prices, and even after 20 decisions convergence to the fundamental value is rare. We also report some interesting differences with respect to subjects’ fields of study. Reassuringly, the behavior of the consultants turns out to be not significantly different from the remaining subjects.informational cascades; herding; contrarians; experiment; internet