Abstract:

We empirically investigate the relationship between informed trading and herding at the market-wide level in China for the 2003-2022 period and find a negative contemporaneous relationship between informed trading and herding, which grows stronger for periods characterized by specific market/economic conditions (low market performance; low market volatility; high investors’ sentiment; high traders’ disagreement; low economic policy uncertainty; high consumer confidence). Herding in Chinese markets comprises of a very strong noise-driven herding, alongside a distinct fundamentals-driven anti-herding, and we show that informed trading dampens the former, while boosting the latter. The negative contemporaneous relationship between informed trading and herding grows stronger following the tightening of legal enforcement of anti-insider trading laws in 2012; it is confirmed for a battery of alternative informed trading proxies, with the causal impact of informed trading over contemporaneous herding further established when employing an instrumental variable approach. We also study the dynamic relationship between informed trading and herding and demonstrate that informed trading Granger-causes herding over time. Our evidence suggests that informed traders motivate stronger herding over time (possibly due to noise traders chasing informed trades), while at the same time dampening it contemporaneously, suggesting that they prey on the very herding they attract.​