Does Herding drive market volatility

This article aims to test whether herding behaviour is a driving force of market volatility in the markets of the UK, France and Germany. Drawing on previous research in the area we link GARCH models to measures of herding. Past work in this area directly uses cross-sectional absolute deviation (CSAD)dispersion as a measure of herding and we initially duplicate this approach. However, CSADdispersion is unlikely to be a good herding measure, particularly in this context, as it is itself driven by volatility, regardless of whether herding is present. Hence, we adopt a more valid, new approach by measuring herding using the residual values from a model estimating the amount of CSADdispersion expected if no herding is present. As expected, we find that using CSADdispersion as the proxy of herding, market volatility has a spurious, contemporaneous positive relationship with herding behaviour. In contrast, based on our new approach, we find that herding does cause volatility but the contemporaneous relationship between them is not strong.