Foreign institutional industrial herding in Taiwan stock market

Purpose - The purpose of this paper is to: investigate whether the foreign institutional investors in Taiwan herd towards the stocks in the same industry; identify the causes of industrial herding; analyze whether herding behavior impacts future industrial returns; and trace the changing pattern of industrial herding, especially during the 2007-2008 financial crisis. Design/methodology/approach - This paper applies Sias' herding measure to identify foreign institutional industrial herding behavior. Moreover, to identify the causes and impacts of herding, the authors use regression models to analyze the relationship between foreign institutional demand for stocks in some particular industries and industrial returns, controlling industrial market capitalization, the number of firms in the industry and industrial speculative intensity. The above methods are applied to the full sample period, as well as two sub-periods, respectively, to trace the time-varying trading behavior. Findings - First, on average, foreign institutional investors herd in the Taiwan securities market. They follow each other into and out of the same industries. Second, they were momentum traders in the tranquil period from 2002 to 2006 and contrarian traders in the period of 2007-2008 financial crisis. Third, such herding behavior has positive impacts on future industrial returns both in the tranquil period as well as in turbulent time. The authors thus conclude that foreign institutional investors demonstrated contrarian trading strategies to stabilize future industrial returns in the financial crisis period; they buy past losers to support the prices and sell past winners to suppress the price volatility. Originality/value - This paper investigates foreign institutional herding behavior in an emerging market, Taiwan on the micro setting of industrial base. It identifies the causes and impacts of foreign institutional industrial herding from the outlook of information-base versus non-information-base trading. It also traces time-varying herding behavior, especially during the 2007-2008 financial crisis. This paper provides useful information to investors participating in emerging markets like Taiwan.