Question

Briefly define anchoring and herding, differentiate them from each other and describe how they would be applied for an individual investor.

Answer 1

Anchoring is a behavioral bias in which irrelevant information ,such as the purchase price of the security is used as a reference for evaluating or estimating an unknown value of financial instrument.The anchoring bias suggests that we favour the first bit of information we learn.

Herding is a phenomenan where the investors follows what they percieve other investors doing,rather than their own analysis.They will gravitate towards same or similar investments based almost solely on the fact that many others are buying the same investments.

The difference between the two terms of finance is explained below:

1.Anchoring is a bias where an investor if planning to buy an investment,would anchor information that favors the investment,praise a certain fund or stock in terms of profitability and ignore the parts which speaks about the risks involved in those investments.On the other hand if the investor is aginst the investment,no matter how much the stock or mutual fund is praised by advised by an advisor,the investor would have anchored the facts of the mutual funds or stock being risky,volatile,time consuming and all other facts that favours the decision to not invest in such mutual funds or stock whereas in herding the analyst do not follow his own instinct and follows or favours the decision of a group or leaders opinion and adopts an imitation behaviour.

2.Herding may be done when an investor,analyst lacks confidence in their private information and there is uncertainty concerning their information.In herding the analyst underweight or abandon their own private information whereas in anchoring they underweight the forecaster's private information and are biased towards the anchor (i.e overweight the past information).

3. Anchoring is a judgemental bias whereas this is not the case with herding.In herding they do not apply any judgements.They do not act rationally and follows others opinion and belief.

4.Herding behaviour might result in similar patterns across individuals whereas in anchoring the investor deviates from the other investors investment patterns.

5.Herding can overall cause a significant positive impact on investment decision whereas anchoring though may outperform others investors at certain times may mostly have a negative impact on the investment decision.

So individual's investors behaviour is extensively influenced by herding and anchoring. Individual investors have limited knowledge and are more prone towards making physcological errors.So the individual investors has to apply both thes concepts based on the situation or behaviour of the market.Such as during the times of market distress or irregular markets such as market anamoly,price bubbles,rumors presence of herding effect is more likely to be profund and useful.But it cannot be denied that,whenever people are trying to take any decision,they often use an anchor or a focal point as a reference or a starting point.So an individual investor if want to anchor should not make decison on the very first peice of information he learns rather he should collect more information and should not overlook further information that can affect the decision.The investor should give enough consideration to all the vailable information and all the possible options.

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