Do Investors Mimic Trading Strategies of Foreign Investors or the Market: Implications for Capital Asset Pricing

This paper examines the presence of herding on foreign trading at individual stock level and portfolio level in the Colombo Stock Exchange as a response to a long-standing trading belief that investors mimic the trading strategies of foreign investors. The standard CSAD framework of Chang et al (2000) is extended replacing return on market portfolio with return on market foreign portfolio holding in the model specification. The standard CSAD specification is also used to identify the presence of herding towards the market under high market volatility, bullish market condition, high trading and transaction volume, domestic and global market crisis and up and down market conditions. Except for the evidence on herding towards the market under bullish market condition at portfolio level, the regression results under other market conditions do not provide reasonable evidence for the presence of herding on foreign trading or herding towards the market on average. Further, taking CSAD as a proxy for heteroskedastic residuals following the framework of Banz (1981), the capital asset pricing model of Black (1972) is used to test the specification of CSAD. The findings suggest that the form of herding accounted for by CSAD is a manifestation of residual heteroskedasticity.