Ascertaining the extent of market herding and market stress has gained particular importance for regulators, especially central banks. On the one hand, analyzing market herding is important as price trends tend to raise questions on whether sustained increases in asset prices reflect true improvements in the profitability of business or is just a consequence of market herding. On the other hand, uptrend in prices, which are driven by market herding is unsustainable and poses risks of asset price bubbles. Likewise, efforts to identify the build-up of stress in the financial system have been at the forefront of policymakers’ agenda, underscoring the large losses incurred by economic agents and the economy, at large, in the past crises. For this study, econometric methods were used in identifying alarming trends in market herding and critical levels of market stress in the EMEAP region. In estimating the degree of market herding, this study used the Hwang and Salmon (2004) model, which basically measures the relative dispersion of the betas for all the assets in the markets, taking into account the equilibrium conditions in the Capital Asset Pricing Model. In estimating market stress, this study adopts a Principal Component Analysis in estimating an overall index to capture financial market conditions. Results of the Hwang and Salmon (2004) model shows that investors’ herding behavior in the 11 EMEAP member economies generally correspond to the prevailing levels of market stress in their respective economies, resonating well with economic theory: market herding is high (low) when market stress is low (high).
