Herding states and stock market returns

This paper investigates whether herd behaviour states (intense/adverse) affect stock market returns using a fixed effects model to capture cross-sectional and time variability covering the European region. We show that stock market returns depend on past herding states. From December 1992 to December 2020, the mean returns following an intense herding state are 0.26% lower per month over a six-month holding period than following an adverse herding state. Our results are robust to using risk-adjusted returns and a continuous herding variable. We also show that intense herding emerges during periods of lower returns and higher volatility than adverse herding.