Investor-herding and risk-profiles: A State-Space Model-based Assessment

This paper, using the Australian stock market data, examines the investor-herding and riskprofiles link that has implications for asset pricing, portfolio diversification and foreign investments. As investors may herd towards a specific factor, sector or style to combat market conditions for optimizing investment returns, examining such herding can reveal investors' risk profiles. We employ State-Space models for extracting time series of herd dynamics and the proportion of signal explained by herding (PoSEH). Market volatility has asignificant negative effect on PoSEH, with the most/least effect on high/low performance days of stock returns. Using quantile regression, we observe that herding and adverseherding can emerge during the worst and best performance days of stock returns, and that extreme volatility can bring herding to a near halt. The study reveals the presence of a regulated stock market environment and risk-aversion tendencies among investors.