Working Paper 622

On the Robustness of Herds

Patrick J. Kehoe | Stanford University, University College London, Federal Reserve Bank of Minneapolis
V. V. Chari | University of Minnesota, Federal Reserve Bank of Minneapolis

Published May 1, 2002

Herd behavior is argued by many to be present in many markets. Existing models of such behavior have been subjected to two apparently devastating critiques. The continuous investment critique is that in the basic model herds disappear if simple zero-one investment decisions are replaced by the more appealing assumption that investment decisions are continuous. The price critique is that herds disappear if, as seems natural, other investors can observe asset market prices. We argue that neither critique is devastating. We show that once we replace the unappealing exogenous timing assumption of the early models that investors move in a pre-specified order by a more appealing endogenous timing assumption that investors can move whenever they choose then herds reappear.

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