# Herding boosts too-connected-to-fail risk in stock market of China

## TL;DR

This paper reveals that herding behavior creates overly connected stocks in China's stock market, which amplifies systemic risk and can trigger market crashes through contagion effects.

## Contribution

It introduces a novel network-based methodology to analyze how herding leads to systemic risk in stock markets, focusing on stocks sharing mutual funds.

## Key findings

- Herding creates too-connected-to-fail stocks.
- Small declines in influential stocks can cascade into market crashes.
- Supervising portfolio strategies can mitigate systemic risk.

## Abstract

The crowd panic and its contagion play non-negligible roles at the time of the stock crash, especially for China where inexperienced investors dominate the market. However, existing models rarely consider investors in networking stocks and accordingly miss the exact knowledge of how panic contagion leads to abrupt crash. In this paper, by networking stocks of sharing common mutual funds, a new methodology of investigating the market crash is presented. It is surprisingly revealed that the herding, which origins in the mimic of seeking for high diversity across investment strategies to lower individual risk, will produce too-connected-to-fail stocks and reluctantly boosts the systemic risk of the entire market. Though too-connected stocks might be relatively stable during the crisis, they are so influential that a small downward fluctuation will cascade to trigger severe drops of massive successor stocks, implying that their falls might be unexpectedly amplified by the collective panic and result in the market crash. Our findings suggest that the whole picture of portfolio strategy has to be carefully supervised to reshape the stock network.