Abstract: Herding and contrarian strategies in financial markets produce informational inefficiencies because investors ignore private information, instead following or bucking past trends. In a simple trading environment, I demonstrate theoretically that investors with prospect theory preferences ignore private information by following a strategy that looks like herding or contrarianism, but which is actually trend-independent. I confirm the theory's predictions in a laboratory experiment designed to rule out other sources of these behaviors, and find that approximately 70% of subjects exhibit herd-like behavior. Finally, I perform a calibration exercise using actual market data to demonstrate the applicability of the results to more general settings.

Bio: Chad Kendall is an economist that specializes in financial economics and political economy. He is particularly interested in questions related to the acquisition and use of information in these domains. His work has been published in the American Economic Review and his current projects look at the ability of markets to aggregate information, both theoretically and experimentally. He previously worked as a semiconductor engineer.