Better ways to test for herding

In this article, we outline problems with the standard test for herding developed by Chang, Cheng and Kohrana (2000), subsequently called the CCK test, which is based on the proposition that the cross-sectional absolute deviation of stock returns (CSAD) should be linearly related to overall market returns. We show that the test is highly biased against finding herding. The bias arises because the test assumes that, in the absence of herding, stock prices follow the Capital Asset Pricing Model (CAPM) but does not account for the implications of the CAPM not being a perfect asset pricing model. We suggest several simple alternative tests for herding. Finally, we show that the new tests give radically different results to the CCK test finding herding in many of the world's major financial markets when the CCK test rejects herding.