Mustafa Hussein Abd-Alla, Mahmoud Sobh

The Impact of Herding on the Risk Pricing in the Egyptian Stock Exchange

Introduction

The impact of herding on the risk pricing in the egyptian stock exchange. Investigate herding behavior's impact on risk pricing in the Egyptian Stock Exchange (EGX) using an extended Fama and French model. Finds no significant effect of herding on EGX risk pricing.

Abstract

We test the impact of herding behaviour on the risk pricing in the Egyptian Stock Exchange (EGX) by adding an additional risk factor reflecting herding behaviour to the Fama and French three-factor model. We construct a portfolio to mimic an additional risk factor related to herding behaviour, in addition to the original risk factors in the Fama and French three-factor model. The three-factor model will be tested in its original form and re-tested after adding the herding behaviour factor. The study is based on Hwang and Salmon methodology, in which the state space approach based on Kaman’s filter was used to measure herding behaviour. We used monthly excess stock returns of 50 stocks listed on the EGX from January 2014 to December 2018. The results do not support Fama and French model before and after adding the herding behaviour factor, therefore, there is no effect of herding behaviour on the risk pricing in the Egyptian Stock Exchange.

Review

This paper critically examines the influence of herding behavior on risk pricing within the Egyptian Stock Exchange (EGX). Employing an extension of the Fama and French three-factor model, the authors introduce a novel risk factor specifically designed to capture herding dynamics, measured through the Hwang and Salmon methodology leveraging a Kalman filter-based state-space approach. Analyzing monthly excess returns from 50 EGX stocks over a five-year period (January 2014 to December 2018), the study investigates whether herding significantly contributes to risk pricing. The central finding indicates that neither the original Fama and French model nor its augmented version with the herding factor effectively explains risk pricing in the EGX, leading to the conclusion that herding behavior has no discernible impact. The research addresses a highly pertinent topic, particularly within the context of emerging markets such as Egypt, where behavioral biases and informational asymmetries are often hypothesized to exert a greater influence on market dynamics. The methodological choice of extending a prominent asset pricing model like Fama and French, coupled with a sophisticated measure of herding derived from Hwang and Salmon's state-space approach, demonstrates a commendable commitment to analytical rigor. The clarity of the research question and the direct empirical testing strategy are notable strengths, providing a transparent framework for investigating the hypothesized relationship. Furthermore, the chosen dataset, encompassing 50 EGX stocks over a meaningful five-year period, appears suitable for the scope of the study. While the study's decisive rejection of both the Fama and French model and the additional herding factor's impact is a clear outcome, it opens avenues for deeper discussion within the full manuscript. The finding that the Fama and French model itself lacks support in the EGX, even prior to introducing the herding factor, is significant. This suggests a fundamental limitation of this particular asset pricing framework in the Egyptian market, prompting the need for further exploration into why conventional models may be inadequate and what alternative, potentially market-specific, factors might better explain risk pricing. Despite the negative findings regarding the initial hypothesis, the paper offers valuable empirical insights into the unique characteristics of the Egyptian stock market and the challenges of applying standard asset pricing models, underscoring the importance of context-specific financial research.

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