Behavioral economics; behavioral finance; social psychology

Herding Theory

When many people are doing the same thing, ask whether they have independent evidence or whether everyone is simply copying everyone else.

Popularity

Usefulness

Aliases

Herd Behavior Theory / Herding Behavior / Herd Mentality / Informational Cascades / Rational Herding

Domains

Finance, economics, investment behavior, consumer behavior, organizational behavior, social influence, decision theory

Definition

Herding Theory describes situations where individuals follow the actions or decisions of others instead of relying mainly on their own private information, analysis, or judgment. In economics and finance, this may happen even when individuals are rational, because other people’s actions may appear to contain useful information. (JSTOR)

People often treat the behavior of others as a signal. When enough people follow earlier actors, later actors may ignore their own information and join the crowd, producing conformity, bubbles, fads, panics, or synchronized decisions. (SSRN)

One person observes the actions of earlier people.
The person assumes those actions may reflect hidden information.
Later people copy the earlier choices.
As copying accumulates, the group behavior becomes self-reinforcing.
The result may be useful coordination, but it may also produce fragile or mistaken collective behavior.
In finance, researchers distinguish intentional herding from “spurious herding,” where people act similarly because they face the same information, not because they are copying each other. (IMF)

An investor buys a stock mainly because many other investors, analysts, or online communities are buying it, even though the investor’s own analysis is weak or incomplete.

Example: Tulip Mania is often used as a famous example of herd behavior in financial markets.
Why it fits this rule: It is commonly presented as a case where rising prices and social imitation encouraged more people to join a speculative market.
Verification status: Disputed / partially verified. Tulip Mania was a real historical event, but the popular story of mass irrational crowd madness is debated by historians and economists. It should be used as a cautionary example, not as a clean proven case of Herding Theory. (Smithsonian Magazine)

Do not label every group action as herding.
Do not use it when people independently reach the same decision from the same public information.
Do not use it as a simple insult meaning “people are stupid.”
Do not assume herding is always irrational; some models show rational individuals may herd under uncertainty.
Do not treat famous market bubbles as automatically proven herding cases without evidence.
Do not confuse Herding Theory with ordinary popularity, tradition, or coordinated planning.

Invented by: No single inventor. Herding Theory developed across economics, finance, and social psychology.
Year of invention: No single year. Important formal economic and financial models appeared around 1990–1992.
Country / context of origin: Mainly academic economics and finance research in the United States and related international research contexts.
Important origin note: The user’s working summary is close but needs correction: the reputation-based model is mainly associated with David S. Scharfstein and Jeremy C. Stein’s 1990 paper, not “Scharfstein 1992.” Their model explains how reputation concerns can make managers imitate others. (JSTOR)

Scharfstein and Stein’s 1990 model explains reputational herding among investment managers. (JSTOR)
Banerjee’s 1992 model shows how sequential decision makers may rationally follow previous decisions instead of using their own information. (JSTOR)
Bikhchandani, Hirshleifer, and Welch’s 1992 work explains informational cascades, where people follow earlier actions and group behavior can shift quickly. (Stanford Network Analysis Project)
Devenow and Welch’s 1996 review summarizes rational herding models in financial economics. (ScienceDirect)
Social psychology evidence on conformity, such as Asch’s conformity experiments, is related but not identical to economic herding theory. (Wikipedia)

When many people are doing the same thing, ask whether they have independent evidence or whether everyone is simply copying everyone else.