Herding in Bank Panics
The work of Devenow and Welch (1996) states that the most basic of human instincts is likely to be that of "…imitation and mimicry" which are the primary characteristics in what is known as 'herding' which often specifically occurs related to such as "fashion and fads…" (Devenow and Welch, 1996, p.603) Devenow and Welch go on to state that among financial economists there is a belief that "investors are influenced by the decisions of other investors and that this influence is a first-order effect." (p.603)
It is reported in the work of Donaldson (1992) entitled "Sources of Panics: Evidence from the Weekly Data" that panic is defined by Jevons (1884) as "a rapid rise in the rate of discount, a sudden flood of bankruptcy and a fall in consols, followed by a rise" (p.8). It is additionally reported that Calomiris and Gorton (1991) "define a panic as an event during which depositors "…at all or many banks in the banking system suddenly demand that banks covert their debt claims into cash (at par) to such an extent that banks suspend convertibility of their debt into cash or…act collectively to avoid suspension (p.112)." (Donaldson, 1992, p.277)
Edward F. Renshaw writes in the work entitled "Stock Market Panics: A Test of the Efficient Market Hypothesis" that the "fashion for person in the academic world has been to assume that changes in stock prices are nearly, if not quite perfectly, random and that the market for equity capital is fairly efficient." (p.48) According to Renshaw, this is quite simply not the case. Short-run changes in prices of stocks are stated by Renshaw to be "very higgledy-piggledy" with evidence of patterns emerging in the longer-run changes in stock prices. (1984)
II. Research Objective
The research project proposed herein would involve spending the next twelve (12) months studying existing work in this field of study and exploring the neurological basis of financial manias and panics under the supervisions of professor Morck and Silverstone.
III. Significance of Research
The significance of this research is the additional information and knowledge that will be added to the already existing knowledge base in this area of study.
IV. Statement of the Problem
There appears to be psychoneurological bases for the 'herding' behavior of individuals on banks in financial and economic crises but this is little understood.
V. Research Methodology
The research methodology chosen for the research proposed herein is of a qualitative nature and will involve an extensive review of literature in this area of study in order to better understand the phenomenon of herding behavior.
VI. Literature Review
Formal explanations based on theory of panics have focused on various elements of the panics. For example, individuals such as Bryant (1980), Diamond and Dybvig (1983) and others focus on examining why 'run the bank' "…is a rational equilibrium outcome for economy populated by sequentially servicing banks who promise to pay depositors more than the liquidation value of bank assets. Bank runs occur in these models when each depositor believes that others will attack an intermediary and force it into costly liquidation. The fear of being last in line at an ultimately insolvent bank causes everyone to run and thus produces a panic. Panics in these models are treated as randomly occurring events in that there is no explicit mechanism by which one can predict whether or not a panic will occur on any given date." (Donaldson, 1992, p.281-282)
It is reported that a second line of research includes individuals such as Jacklin (1983), Smith (1984), Gorton (1987), Chari and Jafannathan (1988) and others who focus primarily on information problems inherent in the bank-depositors relationship." (Donaldson, 1992, p. 282) This vein of research is focused on the fact that an individual depositors "…cannot easily observe the true liquidation value of bank assets and cannot determine whether another depositors who withdraws from the bank is doing so to satisfy a genuine liquidity need or whether the withdrawal is being made because the other depositors has received a private signal regarding the bank's insolvency practices." (Donaldson, 1992, p. 282) In this model, panics are more likely to occur 'when many agents receive a negative signal regarding the value of bank assets or when the general level of economic uncertainty is greatest." (p.282) These models are reported to indicate that the likelihood of a panic is greatest during periods characterized by "general financial distress." (Donaldson, 1992, p.282)
Donaldson (1992) reports that a third vein of research focuses on the "importance of market liquidity in determining the nature of panics." (p. 282) For example, Bhattacharya...
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