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Investor Herding Behavior from the Perspective of Behavioral Finance: Formation Mechanisms, Market Impacts, and Governance

Author(s)

Tiantian Zhang, Hailing Xie*

Affiliation(s)

School of Finance, Fuzhou University of International Studies and Trade, Fuzhou, Fujian, China *Corresponding Author

Abstract

Herding behavior is widely observed in behavioral finance, and its formation and market consequences are closely related to the conditions in which it occurs. Drawing on a review of the existing literature and theoretical analysis, this paper examines the formation mechanisms, market impacts, and governance pathways of herding behavior. The analysis indicates that herding is mainly related to information asymmetry and informational cascades, reputation and principal–agent mechanisms, psychological biases and sentiment contagion, as well as market structure and the institutional environment. The role played by these mechanisms can differ among investor types and across market states. Herding does not necessarily have the same effect on financial markets. Spurious herding and some forms of information-driven herding may not impair market efficiency. Emotion-driven herding, however, can weaken price discovery and amplify market volatility when it lacks sufficient informational support. To address the potential adverse effects of irrational herding on market efficiency, this paper proposes a coordinated three-level governance framework. The framework centers on improving the information environment, refining trading mechanisms and regulatory institutions, and strengthening incentive and constraint mechanisms for institutional investors.

Keywords

Herding Behavior; Behavioral Finance; Information Cascades; Market Efficiency; Investor Governance

References

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