The herd behavior index: A new measure for the implied degree of co-movement in stock markets

We introduce a new and easy-to-calculate measure for the expected degree of herd behavior or co-movement between stock prices. This forward looking measure is model-independent and based on observed option data. It is baptized the Herd Behavior Index (HIX).The degree of co-movement in a stock market can be determined by comparing the observed market situation with the extreme (theoretical) situation under which the whole system is driven by a single factor. The HIX is then defined as the ratio of an option-based estimate of the risk-neutral variance of the market index and an option-based estimate of the corresponding variance in case of the extreme single factor market situation. The HIX can be determined for any market index provided an appropriate series of vanilla options is traded on this index as well as on its components. As an illustration, we determine historical values of the 30-days HIX for the Dow Jones Industrial Average, covering the period January 2003 to October 2009.