The purpose of this paper is to test the herding effect among bitcoin exchanges around the expiration date of bitcoin futures. The emergence of bitcoin futures contracts in regulated markets offers a unique opportunity to analyse the mimetic behaviour of investors more closely. Bitcoin futures have attracted interest from institutional investors who consider this new asset an additional investment opportunity. This interest helps to increase the liquidity of the spot market and leads to the appearance of sophisticated investors in Bitcoin markets. If these investors seek to take advantage of the expiration time in their speculative or arbitrage strategies, less informed investors will probably monitor and imitate their movements.
Using intraday data and an unconditional model, we confirm, on average, anti-herding behaviour for the period. However, our results go one step further by showing that at certain moments, in which the discovery of strategies and information overload are key features, herding may appear if investors find difficulties in processing information to generate their expectations. Consistent with our hypotheses, we find a strong herding effect before expiration and a few hours after expiration. Specifically, these effects extend throughout the week prior to expiration and disappear quickly the day after expiration.
The results suggest that bitcoin prices generally reflect investors’ own information, but particularly in the week of bitcoin futures expiration, this point is questionable since investors seem to watch each other closely. If the herding effect is evident during the expiration week, the information flow may not be as informative and could be contaminated.
The herding effect should be studied in detail since, as our findings indicate, it is not homogeneous at all times. The influence of important factors such as fear of missing out (FOMO), confirmation bias and overconfidence (see, among others, Merkle and Weber (2011) or Baur and Dimpfl (2018)) on the psychology of investors that causes the decision to herd means that herding is important enough to be analysed conditioned by the occurrence of different events and in various markets. In addition, the strong growth in bitcoin trading is itself the result of psychological factors that make this analysis even more interesting. Furthermore, as Corbet et al. (2019) point out, there must be ongoing research on cryptocurrencies since their behaviour is continually changing.
In general, the direct consequences of herding for financial investors occur in two ways. On the one hand, herding makes it more difficult to diversify investment portfolios, and on the other hand, financial assets may be mispriced due to price pressures that increase volatility and market instability and that can therefore drive prices away from their expected values. In our paper, the first consequence does not have great implications for relevant investors since we analyse the herding that occurs between exchanges that trade the same asset, bitcoin, and, presumably, their diversification strategies mainly focus on different assets instead of the same asset in different markets or on different platforms. However, mispricing can affect all investors in all exchanges at maturity times, with the exception of bitcoin holders (hodlers), whose objective is long-term gains.
Around maturity time, investors are aware of the number of informational elements that may influence decision-making. For this reason, many uninformed investors may find it useful to imitate the decisions of others, transferring that imitation to the different exchanges where bitcoin is traded. Herding between exchanges can amplify the mispricing of bitcoin since imitation spreads throughout different markets and platforms. Consequently, market players will not be able to adequately predict prices and may find volatility levels that intensify the risk assumed. In volatile markets such as crypto markets and at times of volatility, price slippages tend to occur. Therefore, at the time of executing a transaction during herding periods, asset prices can shift noticeably before the transaction is completed. Hence, exchanges should ensure that liquidity providers such as market makers (makers) and liquidity pools create multiple bid-ask orders to match the orders (especially large orders) of other traders to execute transactions instantaneously and to reduce price slippages.
More specifically, our results also have implications for investors who design their strategies encompassing several exchanges since they must take into account that price differentials narrow in the hours close to expiration. Consequently, market participants who act as arbitrageurs or hedgers betting on different exchanges in bitcoin will have more limited possibilities of obtaining profits. Arbitrage traders who participate in triangular arbitrage trading (which involves spotting the price differences between three different cryptocurrencies, even on the same exchange) should review their strategies involving bitcoin, while hedging and arbitrage investors operating in both the spot and futures markets should review their hedge ratios.
Policy makers should also realize that the expiration week is an atypical week in which exchanges tend to follow the market consensus. This behaviour could be worrying in the case of large market fluctuations when the risk associated with feelings of pessimism or euphoria could spread to all exchanges.
In financial markets, decision-making is a significant issue. Herding is a consequence of decision-making, which is why it is interesting to understand it from different perspectives. In the future, to further investigate investors’ behaviour in financial markets, as Zha et al. (2020) suggest, it will be necessary to conduct integrated in-depth interdisciplinary research.