The Herding Behavior of Investors in the Indian Financial Market: An Insight Into the Influence of Social Media

Introduction

Comprehending how market participants make decisions has always been extremely difficult for academics and practitioners alike. Numerous studies have shown the efficient market theory’s main limitations in simulating stock return patterns. According to behavioral financial theory, stock market actions can be influenced by an investor's feelings or ideas (Summers, 1986). According to the traditional finance theory, investors establish reasonable expectations of future prices and instantly discount all available market data into expected prices similarly. However, the rationality of investors has always been called into question by major investors, and this rationality and information access and discounting have formed reasons for the major criticism of the traditional theory of finance. Investors create homogeneous expectations based on all accessible information, are perfect rational utility maximizers, and know that others utilize this publicly available information the same way they do, according to the theory of efficient markets. One can find different schools of thought, disciplines, and subdisciplines to study money and investments in the past, present, and future. Numerous groundbreaking studies on stock returns have been done in modern finance, like Markowitz’s Asset Pricing Theory (1952) and CAPM, The Capital Asset Pricing Model (1960s) were quantitative models for quantifying unsystematic risk. Sharpe (1964), and Lintner (1965), studied and introduced portfolio theory. Efficient Market Hypothesis (EMH) studied by (Fama 1965), the Modigliani-Miller (1988) approach for option pricing in investment decisions. All the above-mentioned theories discredit the fact that two investors having same set of data are still earning different returns. This was later explained by two renowned psychologists Kahneman & Tversky in their groundbreaking work. They claimed that the investors do not only exhibit rationality but there also exist psychological components of the investors (Priya et al., 2023). Contrary to traditional theories, traders are not always rational, and their decision making is often influenced by their belief system and information retention and processing powers. The Behavioural finance theory tries to explain the difference in returns for two identical investors as the emotional response to the information assimilated. The emotional response depends on various psychological aspects of investors, thereby leading to the impact on buying and selling decisions of the investors. Financial decision-making is influenced by investors' psychological makeup, according to behavioural finance (Sinha, 2023). We are aware that people make decisions based on their emotions. These judgments frequently have an inefficient and illogical nature and can result in stock market catastrophes. The most historic occurrence of these calamities is possibly documented by (Mackay, 2012) including the occurrence of Tulip Bubble. Market anomalies including speculative bubbles, overreaction to new information, and underreaction to it are evidence that there is more to financial decision-making than a cold, calculative rational agent. Thus, the necessity to comprehend these anomalies and the flaws in human judgment they involved gave rise to behavioural finance. Investors exhibit behavioural biases that fall short of perfect rationality (Jaiswal and Sinha, 2023). Their mood, market sentiment, and other seemingly unrelated external influences can all have an impact on their investment decisions. In the financial markets, herding is often defined as the propensity of an investor to mimic the behavior of others. Alternately, herding is a term frequently to describe the correlation in trades brought on by investor contacts. Since using their own information/knowledge would be more expensive, less experienced investors who try to emulate financial gurus or emulate the actions of successful investors are thought to be justified for engaging in this behavior. Consequently, this herding behavior is a note, ‘‘a group of investors trading in the same direction over a period”. Empirically, this may result in observed behavior patterns that are associated across people and that cause entire groups to make systematically bad decision (Jaiswal et al., 2023). Investors must therefore choose a greater variety of securities with a lower degree of correlation to attain the same level of diversification. Additionally, investors' trading behavior may lead asset values to vary from economic fundamentals if market participants tend to herd around the market consensus. This behaviour has been identified as one of the major factors impacting the asset pricing and thus cannot be ignored. Investors, especially those having insufficient knowledge of the financial markets, are prone to get affected by this herd mentality (Gupta et al., 2023). The information gathering process by the investors tend to incline towards easily available mediums. With easy access to internets information disbursement and information gathering, both are equally seen on the social media platforms. It has become easier to gather information impacting the corporations and economy from these social media platforms than watching a full hour news. Platforms like Facebook, X (formerly Twitter) and Instagram have emerged as the most visited platforms. These mediums have become a storehouse of information about diverse topics (Kumar et al., 2023). An investor holding incomplete knowledge regarding trading and investment tends to gather information from these sources. Interactions on social media platforms have the potential to change people’s information environments and trigger feedback cycles that could result in emotive hype. These effects may then have an impact on how investors trade, asset prices, and market efficiency.