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Contents : Herding Behavior of Mutual Fund Managers in Germany Andreas Oehler* Chair of Finance Bamberg University Department of Management Business Administration and Economics Kirschaeckerstr. 3 9 D-96045 Bamberg Tel.: (+49) 951-863-2536 Fax: (+49) 951-863-2538 e -mail: andreas.oehler@uni -bamberg.de Stefan Wendt Bamberg University Department of Management Business Administration and Economics Kirschaeckerstr. 3 9 D-96045 Bamberg Tel.: (+49) 951-863-2696 Fax: (+49) 951-863-2538 e-mail: stefan.wendt@uni-bamberg.de This Draft: November 7 2008 Abstract Herding behavior i.e. the adjustment of a decision maker behavior opinion or expectations s due to real or illusionary (social) pressures can be explained by numerous behavioral finance models such as the cascade model or contagion. However unambiguous empirical results are rare mainly due to differing methodologies used in previous studies. We analyze the buying and selling activities of the managers of German mutual funds that primarily invest in equities over the period from 2000 to 2005. Our dataset covers about 70 percent of the total investments of all German equity mutual funds. Our results reveal that there is considerable herding behavior when mutual fund managers face market-wide cash inflows or cash outflows. In addition mutual funds that only invest in German equities display stock-picking herding behavior when selecting which stocks to invest in. Key Words: * Herding behavior Mutual funds Behavioral finance Contact author We thank Oliver Schwindler and Thomas J. Walker for helpful comments and several mutual fund companies for providing us with their reports. We are grateful to Karla Bender Nadine Bleise Ralf Borger Andreas Hanke Nicolas Jaekel Ralf Kastenholz Nadine K nig Felix Miederer Kristina Ondrusch Peter Thomas and Kerstin Voeller for technical support. Herding Behavior of Mutual Fund Managers in Germany Abstract Herding behavior i.e. the adjustment of a decision maker behavior opinion or expectations s due to real or illusionary (social) pressures can be explained by numerous behavioral finance models such as the cascade model or contagion. However unambiguous empirical results are rare mainly due to differing methodologies used in previous studies. We analyze the buying and selling activities of the managers of German mutual funds that primarily invest in equities over the period from 2000 to 2005. Our dataset covers about 70 percent of the total investments of all German equity mutual funds. Our results reveal that there is considerable herding behavior when mutual fund managers face market-wide cash inflows or cash outflows. In addition mutual funds that only invest in German equities display stock-picking herding behavior when selecting which stocks to invest in. Key Words: Herding behavior Mutual funds Behavioral finance 1 Introduction Herding behavior is characterized as the adjustment of a decision maker behavior opinion or s expectations due to real or illusionary (social) pressures. This behavioral element of the herding phenomenon distinguishes herding behavior from merely positively correlated behavior within a group of decision makers. In financial markets where virtually every group of investors can exhibit herding behavior the pressure to follow others can result from (1) mental processes such as a similar perception and interpretation of information (so-called observational and informational herding) or (2) (monetary) incentives or fiduciary duties such as accounting (socalled reputational herding or herding driven by payoff and network externalities). Herding behavior may emerge in the form of active buying and selling activities but also in the form of collective passiveness towards the investment in certain securities (so-called passive herding). This idea is based on the theory of decision making that suggests that a non-decision is a decision in itself. Within the field of behavioral economics and behavioral finance herding behavior is a phenomenon of particular importance due to its impact on the (in)effectiveness of market mechanisms and on the outcomes of financial markets. To date herding behavior has primarily been analyzed and documented in the equity market. Although there have been prior studies that e xamined herding behavior among German mutual fund managers (see e.g. Oehler 1995 and 1998) most of them were based on a time period in which the German mutual fund industry remained comparatively small. Since then the German mutual fund landscape has developed extensively to an industry on its own. This development and the increasingly large price impact of mutual fund order flows (see Oehler and H cker 2004) call for a reexamination of the investment behavior of German mutual funds. Our study attempts to fill this gap. 2 Our empirical analysis focuses on the investment behavior of German mutual fund managers who primarily hold equity securities in

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