January 31, 2013 / 10:12 PM / 5 years ago

Investors prone to herding in corporate bonds -Fed paper

WASHINGTON, Jan 31 (Reuters) - Institutional investors are more prone to “herd-like” behavior in the U.S. corporate bond market than in stocks, according to researchers at the Federal Reserve.

A Fed research paper that was posted online earlier this month highlights investor dynamics that could intensify price movements in the U.S. corporate bond market, where issuance has soared as companies take advantage of ultra-low borrowing costs.

The paper, “Institutional Herding in the Corporate Bond Market,” takes a rare look at the U.S. corporate bond market from the point of view of the prevalence of “herding,” in which investors appear to follow each other’s buying or selling.

“We find substantial institutional herding in U.S. corporate bonds, much higher than that previously documented in the equity markets,” wrote authors Fang Cai, Song Han and Dan Li, who are all staff economists at the Federal Reserve Board in Washington.

One of the factors contributing to this behavior in the corporate bond market was concern that institutions would suffer damage to their reputations if they failed to follow their peers, especially when selling a bond. Such behavior tended to harm returns on the investment even more.

“We find significant return reversals in the post-herding trades, especially for sell herding. This finding suggests that sell herding in the U.S. corporate bond market destabilizes bond prices,” the authors said.

Some Fed officials worry their extraordinary policy actions to prop up U.S. growth could help fuel asset bubbles that might be very damaging to financial stability if they burst.

These officials, including Esther George, president of the Kansas City Federal Reserve Bank; and James Bullard, the St. Louis Fed chief; have cited high bond prices as a potential source of concern. As a consequence of the Fed’s bold actions, bond prices have surged, pushing yields close to historic lows.

U.S. high-grade corporate bond issuance surged above $111 billion at the start of this year and was on track to make January 2013 the second-busiest issuance month on record, according to IFR, a unit of Thomson Reuters.

The Fed has held overnight interest rates at near zero since late 2008 and tripled the size of its balance sheet to around $3 trillion through three massive bond purchase programs, in which it has snapped up both mortgage-backed securities and Treasury debt.

The U.S. central bank on Wednesday, at the close of its first policy meeting of the year, said it had decided to maintain the pace of its bond purchases at $85 billion a month.

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