, Volume 43, Issue 1, pp 99-126

Deconstructing Herding: Evidence from Pension Fund Investment Behavior

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Abstract

In this paper, we examine herding across asset classes and industry levels. We also study what incentives managers at various layers of the financial industry face when investing. To do so, we use unique and detailed monthly portfolios between 1996 and 2005 from pension funds in Chile, a pioneer in pension-fund reform. The results show that pension funds herd more in assets that have more risk and for which pension funds have less market information. Furthermore, the results show that herding is more prevalent for funds that narrowly compete with each other, namely, when comparing funds of the same type across pension fund administrators (PFAs). There is much less herding across PFAs as a whole and in individual pension funds within PFAs. These herding patterns are consistent with incentives for managers to be close to industry benchmarks, and might be also driven by market forces and partly by regulation.

We are indebted to the Chilean Superintendency of Pensions for giving us unique data and support that made this paper possible. For very useful comments, we thank Solange Berstein, Matías Braun, Anderson Caputo, Pablo Castañeda, Pedro Elosegui, Eduardo Fajnzylber, Gregorio Impavido, David Musto (the Editor), Gonzalo Reyes, Luis Servén, an anonymous referee, and participants at presentations held at the LACEA Annual Meetings (Buenos Aires, Argentina), NIPFP-DEA Workshop (Delhi, India), Superintendencia de Pensiones and Universidad Alfonso Ibañez (Santiago, Chile), and World Bank Group (Washington, DC). For excellent research assistance, we are especially grateful to Ana Gazmuri and Mercedes Politi. We also thank Alfonso Astudillo, Leandro Brufman, Francisco Ceballos, Lucas Núñez, and Matías Vieyra, who ably helped us as research assistants at different stages of the project, and Jonathan Moore, who edited the paper. The World Bank Research Department and the Knowledge for Change Program provided generous financial support. The views expressed here do not necessarily represent those of the Central Bank of Chile or the World Bank. The authors are with the Central Bank of Chile and the World Bank, Development Research Group, respectively. Email addresses: craddatz@bcentral.cl and sschmukler@worldbank.org.