An Examination of Herd Behavior in the Indonesian Stock Market

We examine herd behavior in Indonesian Stock Exchange, using daily and weekly stocks return from 2007 until 2010. We employ the cross-sectional standard deviation of returns (CSSD) methodology developed by Christie and Huang (1995) and cross sectional absolute dispersion (CSAD) methodology developed by Chang, Cheng and Khorana (2000) to detect the presence of herd behavior. Using daily and weekly CSSD, we document the nonexistence of herding behavior in Indonesian stock market. However, using CSAD of either data frequency the result demonstrates the presence of herding behavior, particularly on big capitalization and liquid stocks. The result differs from Chang, Cheng, and Khorana (2000) who find no different impact of herding behavior across size-based portfolios.


Introduction
Although it has been strongly argued that Indonesian economy is relatively strong compares to major developed economies, the 2008 global economic shock apparently has caused a bigger price decline in Indonesian stock market compared to the US stock market, where the root of the problem is. The credit and housing crisis suppress the US economy which in turn cause a plunge in the stock market which is started on October 2007 -when the Dow Jones Index reach its highest leveland reached (or presumably has reached) its bottom in March 2009. It took around one and a half year for the index a decline of 51.1% from its top. In contrast with Indonesia, Indonesian composite index (ICI) unpredictably dropped 60.7% in just less than 10 months, from its top in January 2008 to October 2008 when it reached its bottom.
During the global economic downturn, Indonesia evidently exhibits a strong domestic growth where it still experiences a moderate positive growth while major economies suffer recession. Indonesia's strong resistance to global economic crisis is because it structure of GDP which is composed majorly from domestic consumptionsaccounts around 65% of its GDP.
This fact in by some means support the idea of economic decoupling which attracted many economist interest just before the crisis. However, as mentioned before, there was a perplexing reality regarding the Indonesian stock market movement at some point in the global economic downturn.
One way to argue with this, there's a high probability that Indonesian stock market has experienced a herd behavior. Banerjee (1992) define herd behavior as how investors will be making investment decision by mimicking other investors rather base it using their own information. However, it is still not clear what causes herd behavior. Some academic researches argue that it is rational and intrinsic while others says that it violated the rational capital asset pricing theory. Bikhchandani and Sharma (2000) documented several studies that suggest herd behavior is rational: Banerjee (1992), Bikhchandani, Hirshleifer, and Welch (1992), and Welch (1992) who suggest herd behavior is information based and cascade; Scharfstein and Stein (1990) argue that investment managers might be engaged in herding suppress their confidence on their ability in managing portfolio and follow other actions instead; and Maug and Naik (1996) that explore the possibility of investors or investment agents whose compensation is tied on their performance over a benchmark(s) could make investment decisions solely to mimic the benchmark portfolio.
In this paper, we study the possibility of herd behavior during a market crash by examining Indonesian stock market in 2008 financial crisis and aftermath. We rework the study conducted by Christie and Huang (1995) and Chang, Cheng, and Khorana (1999) that use the dispersion of individual stock returns to the market return as a measure of herd behavior. Christie and Huang (1995) carried out an empirical test over herd behavior in the US equity market employing cross-sectional standard deviations (CSSD) of returns. They suggest that when herding take placethat is when investors create investment decisions by following others and curb their own beliefs or their own informationindividual stock returns will not deviate considerably from the overall market return, indicated by smaller CSSD than normal. Chang, Cheng, and Khorana (1999) extended the work of Christie and Huang (1995) in at least 2 (two) ways. First, instead of using CSSD, Chang, Cheng, and Khorana (1999) use cross-sectional absolute deviations (CSAD) of returns to measure the existence of herd behavior. The basic idea of CSAD is to calculate the deviation of expected market return and expected individual stock returns that calculated using the Black (1972) CAPM. Secondly, they introduce a non-linear regression specification to describe the occurrence of extreme herding.
We use both the CSSD and the CSAD measures to identify the existence of herd behavior in Indonesian equity market. We focus on the 2008 financial crisis and the aftermath.
Examining herd behavior in that period of time is interesting since the market crash in 2008 happened was major macroeconomic factors show a strong fundamental. There was a strong argumentation that suggesting the market decline was caused by a herd behavior following the action of foreign investors that pull out their investment to raise more capital to fulfill regulatory requirements.
We also expanded the work of Christie and Huang (1995) and Chang, Cheng, and Khorana (1999) by using not only daily returns but also weekly returns. We use a lower frequency data to explore the extension of time of herd behavior should it occurs. In addition, we perform the tests over liquid (big size) stocks as part of the rework of Chang, Cheng, and Khorana (1999) that investigate asymmetric effect of herd behavior using based on the findings documented by McQueen, Pinegar, and Thorley (1996) that small stocks tend to react slower to response good news.

Methodology
In this section, we use the empirical methodology proposed by Christie and Huang (1995) [henceforth referred as CH] and by Chang, Cheng, and Khorana (1999) [henceforth referred as CKK) to detect the presence of herd behavior in Indonesian equity market. CH propose the use of cross-sectional standard deviation of returns (CSSD) to detect herd behavior whereas CKK suggest the use of cross-sectional absolute deviation of returns (CSAD). CKK has came to the conclusion that the two methods are analogous in spirit, but do not always reach the similar conclusion.
The rational of asset pricing models suggest that the dispersion of individual stock returns and market return is determined by its sensitivity to the market return. On the contrary, CH argue that in the event of herding, investors tend to curb their own belief on the performance of individual stock and emphasize their investment decisions on collective actions of the market.
Hence, individual returns will not diverge too far from the market return. To quantify the dispersions of individual returns from market return, CH suggest the use of CSSD, which measure is defined as where is the number of stocks in the aggregate market portfolio, , is the observed individual stock return at time and , is the cross-sectional average of the returns in the market portfolio. Throughout herding event, the dispersion of cross-sectional returns is expected to increase at a decreasing rate and may lead to the decrease in the case of extreme herding.
Thus, to empirically scrutinize the presence of herd behavior, CH make use of the following formulation: where is a dummy variable set to represent market extreme condition where will equal to 1 if the market return lies in the extreme lower tail of the distribution and equal to zero otherwise; and will equal to 1 when the market return lies in the extreme upper tail of the distribution and equal to zero otherwise. CH uses 1% and 5% percentiles of the distributions to define extreme market price movements.
A negative and statistically significant suggest an increasing at decreasing rate of cross-sectional returns dispersion during extreme market downtrend whilst negative and statistically significant suggest an increasing at decreasing rate of cross-sectional returns dispersion at the time of extreme market uptrend. Both and in the empirical model indicate linear relationships between market return and cross-sectional returns dispersion.
In line with the work of CH, CKK based their examination of herd behavior on the measure of dispersion. Having said that, CKK employ cross-sectional absolute deviation (CSAD) of returns as the measure of dispersion. To demonstrate the relationship between CSAD and the market return, CKK use the conditional version of Black (1972) CAPM expressed as follows: where is the return of risk-free rate and measures the sensitivity of individual stock returns to market movement. Using the same formulation, we can approximate the market return as follows: The dispersion of individual returns and market return can be expressed as the absolute difference between both equations (3) and (4): The expected cross sectional absolute deviation (ECSAD) of returns in period can then be expressed as: CKK differentiated their work from that of CH by relaxing the assumption of linear relationship between market return and the ECSAD and add a non-linear term in their empirical model. Moreover, to capture the possibility of asymmetric responses from market participants in the event of herding CKK suggest that empirical test should be carried out both respectively at the time of market up-movement and at the time of down-movement. To perform such assessment CKK advise the following specification: The test suggest that negative and statistically significant 1 and 2 coefficients indicate that the dispersion of stock returns increase at a decreasing rate in either during market uptrend and/or market downtrend. The non-linear term of the empirical model facilitate the identification of herd behavior in the period of market rallies and/or market sell-offs.
Even though, both the method proposed by CH and CKK share the similar main idea, the two methods may reach different conclusion.

Data
In their paper, both CH and CKK use daily data to examine the presence of herd behavior in the international equity market. To extent of their findings, we use weekly data in addition to daily data. We gather stock prices data for the entire population of listed Indonesian firms in the Indonesian Stock Exchange (IDX) from Yahoo Finance. We choose the period of July 2007 -June 2010 mainly to capture the recent market turmoil (2008) and examine whether herd behavior took place. In determining the sample for our analysis we include stocks that satisfy the following criteria: (i) stocks that exists during the period of the observation (July 2007 -June 2010) and (ii) data availability; and we found 282 stocks that satisfied the abovementioned criteria. We use the 282 samples portfolio as a proxy for the market portfoliocalculated as an equally-weighted index return. We use the first year data to calculate ECSAD and use the ex post data to examine herd behavior. For the sake of comparison, we use the same ex post data to evaluate herd behavior using CSSD measure.
On top of that, we also investigate the existence of herd behavior in big market capitalization portfolio using stocks listed in the LQ45 consists of 45 companies with the highest market capitalization and with the highest transaction value. Because the LQ45 index is updated every 6 (six) months, we only select stocks that existed in the LQ45 list during the period of observation. Given the consideration, there were only 16 firms that remained in the list during the observation. As the proxy for risk-free instrument we choose the 1-month "Sertifikat Bank Indonesia" (SBI)discount fixed income instrument issued regularly by the central bank of Indonesia.

Descriptive Statistics
In this section we present descriptive statistics for market returns, CSSD and CSAD measures both for daily and weekly data. From the summary in Table 1 (Table 3). But as can be seen in Table 3, there is a conflicting result between CSAD and CSSD measures where the highest CSSD measure is recorded in August 2008. Hence, a statistical analysis plays an important role in determining whether the corresponding measure is valid. Table 3. Table 4.

Summary statistics of weekly liquid stocks' return and CSSD and CSAD measures
Furthermore, as we can observe in Figure 1, prior to the market crash, CSSD measures was rising, indicating that investors had a strong confidence regarding individual stock performance over market portfolio performance. We also can see post the market crash CSSD

Cross-sectional standard deviations (CSSD) of market returns from July 2008 until June 2010
The same finding can also be seen from the observation of the CSAD measures ( Figure   2). Prior to the market fallback, investors confidence regarding individual stocks was mounting as indicated by the increasing CSAD measures. Subsequently, investors confidence on individual stocks deteriorated until March 2009. Albeit graphical analysis advise the ability of dispersion measures to predict the presence of herd behavior, proper statistical test should be carried out. Formal statistical test result will be discussed in the next section.
In this paper, we also examine whether using weekly returns instead of daily returns will result in different outcome. Graphically, as can be seen in Figure 3 and Figure 4, both data frequency suggest the same result that both daily and weekly exhibit similar pattern over time.

Weekly vs Daily CSSD (Jul 2008 -Jun 2010)
Weekly CSSD Daily CSSD The regression analysis result on the daily returns of liquid stocks portfolio does not differ from that of market portfolio. This result suggest that there is no relationship between portfolio size (or liquidity) and herd behavior. We documented all the CSSD regression model parameter estimates in Table 5. Table 5.

Regression results of the daily and weekly cross-sectional standard deviations (CSSD) of market returns and liquid stocks portfolio returns
This table reports the estimated parameters of the following regression model: = + + + where = 1 if market returns on day t lies below the 1% percentile of the returns distribution and equals to zero otherwise and in the same manner = 1 if market returns on day t lies above 99% percentile of the distribution and equals to zero otherwise. * denotes that the coefficient is significant at the 5% level and ** denotes that the coefficient is significant at the 10% level.

Regression Analysis on Cross-Sectional Absolute Deviations (CSAD) of Returns
The key in estimating cross-sectional absolute deviations lies in the estimation of the portfolio beta. In this paper we use the single index model to estimate beta of each portfolio.
Due to the difference in data frequency, the estimated individual betas and portfolio betas using daily returns also different from that of weekly returns. The estimated beta of the market portfolio using daily data is 0.78 while the estimated beta of the market portfolio using weekly returns is 0.86. To pursue further analysis, we estimate the beta of the stocks in the liquid stocks portfolio using the portfolio return as market proxy. The estimated beta using this approach result in higher betas than that of market portfolio. The estimated portfolio beta for both daily and weekly data is equal to 1.00. For that reasonas we can see in Table 3 and Table 4 the estimated CSAD measure using liquid stocks portfolio tends to greater than the one estimated using market portfolio.

Market Portfolio Liquid Stocks Portfolio Frequency
During the beta estimation, we also found several stocks which beta regression result are not significant. In these cases, we assume for those stocks that fail to reject the hypothesis that its return depends on the market returnmeasured with beta as a sensitivity measureto have beta equals to zero. Table 6 provide empirical results using the regression analysis of CSAD of market returns as formulated in equation (7a) and (7b). The formula incorporated non-linearity in dispersions of returns. A negative and statistically significant parameter coefficient suggests the evidence in favor of herd behavior in the market. As we can see, during the market uptrend, 1 is significant at the 10% level indicating that investors tends to stem their credence on individual stocks performance and weigh more on market directions. Having said that, the parameter estimate of 2 is statistically insignificant providing no confirmation of any non-linearity in the dispersions and market return relationships. This means that herd behavior may existed during relatively normal upward market direction but not in the event of market rallies.
Even though there is an evidence that herd behavior happened throughout the observation period using daily data, the regression result of 1 and 2 of weekly returns are not significant which advise that herd behavior occurs in a very short period of time.
During market correction however, both parameter of linear ( 1 ) and non-linear ( 2 ) terms of the regression model are not significant, suggesting that the rational capital asset pricing model holds. In line with CKK findings, the average level of individual stocks deviations to market returns (as measured by parameter ) is near zero (0.2% for daily returns and 0.3% for weekly returns). Table 6.

Regression results of the daily and weekly cross-sectional absolute deviations (CSAD) of market returns
This table reports the estimated parameters of the following regression model: where , is the absolute value of an equally-weighted return of all available securities † on day when market is up; , is the absolute value of an equally-weighted return of all available securities † on day when market is down; ( , ) 2 is the squared value of , term and ( , ) 2 is the squared value of , term.
* denotes that the coefficient is significant at the 5% level and ** denotes that the coefficient is significant at the 10% level. † denotes all securities that existed in the list of Indonesian Composite Index (ICI) during the observation period (July 2007-June 2010 McQueen, Pinegar and Thorley's (1996) examined and discovered in their research that stock's market capitalization has no influence on how quick investors react on bad news, however they found evidence indicating that responses on good news is more rapid on big companies. Therefore, we expect that the result of the regression analysis of large cap stocks portfoliousing liquid stocks in LQ45 index as a proxyduring market downtrend will not provide conflicting result with that of regression analysis on market portfolio. and 2 are not statistically significant which is similar to the case of the relationship between market portfolio and the corresponding CSAD. Table 7.

Regression results of the daily and weekly cross-sectional absolute deviations (CSAD) of Liquid Stocks Portfolio
This table reports the estimated parameters of the following regression model: where , is the absolute value of an equally-weighted return of all available liquid stocks † † on day when the portfolio return is positive; , is the absolute value of an equally-weighted return of all available liquid stocks † † on day when the portfolio return is negative; ( , ) 2 is the squared value of , term and ( , ) 2 is the squared value of , term.
* denotes that the coefficient is significant at the 5% level and ** denotes that the coefficient is significant at the 10% level. † † denotes all securities that existed in the list of LQ45 Index during the observation period (July 2007-June 2010 On the contrary, in market upward direction, big size stocks are supposed to react more rapidly on news rather than smaller size stocks. Hence, when the market is up, investors is expected to emphasize their decision on individual stocks performance which means the absence of herd behavior. We see in average portfolio price movement increases. That being said, herd behavior was present in the event of market rally as indicated by a negative and statistically significant 2 . We also find that the event of herding precede in a longer period of time for big size stocks. The parameter of linear and non-linear term of the regression model during market up using weekly returns are both negative and statistically significant which contradicts the previous explanations of McQueen, Pinegar and Thorley's (1996). The regression result suggests that weekly returns exhibited herd behavior during normal market uptrend as well as during market rally.

CONCLUSSION
This study analyses the herd behavior of market participants in Indonesia in the financial crisis in 2008 and aftermath. We use two empirical models cross-sectional standard deviations (CSSD) and cross-sectional absolute deviations (CSAD) which are proposed by Christie and Huang (1995) and Chang, Cheng, and Khorana (1999) respectively.
Our empirical test using CSSD method suggests the absence of herd behavior during the crisis in 2008 and aftermath even though graphical interpretations of indicated the otherwise. The result is consistence in both of daily and weekly data. Our result also shows that has no linear nor non linear relationships with liquid stocks portfolio as it is with market portfolio.
Our empirical test also aligned with that of Chang, Cheng, and Khorana (1999) which suggests that the analysis using and can provide conflicting results. Using daily , we provide evidence of herd behavior of composite stocks during normal market uptrend. Nevertheless, liquid or big size stocks do not exhibit herd behavior during both market downtrend and uptrend as suggested by the findings of McQueen, Pinegar and Thorley's (1996) that big size stocks reacts more rapidly on good or bad news. Hence, in either market directions, in making investment decisions on big size stocks, investor tends to weigh more on individual performance over market sentiment.
Nonetheless, we also arrive to contradictive result for the herd behavior in a longer analysis horizon. We found that in a upward direction, big size stocks experienced herd behavior in normal and intense up movement. Herd behavior was also present during normal market downturn, but nonexistence during extreme one. Regression results using CSAD on weekly returns introduce the possibility of herd behavior occurs in a longer investment horizon.
But this findings needs further confirmation either using greater frequency or longer observation period.