Jeremy C. Stein

Jeremy C. Stein appears in the book as a coauthor of a classic study of herding in financial markets. The study, conducted with David S. Scharfstein, explains why mutual-fund managers may copy their competitors: they must not only invest wisely but also persuade investors that their decisions look reasonable. That professional pressure can make conformity safer than independence, while reducing the range of information the market receives.

Identity and Contribution

Stein is named as one of the authors of a study examining mutual-fund managers’ tendency to follow similar strategies and accumulate in the same stocks. The book’s account centers on the study’s explanation of that behavior rather than on biographical details about Stein or a separate personal role in the research.

The Pressure to Look Wise

The study’s key distinction is between making wise investments and convincing others that one is investing wisely. Investors cannot readily assess a manager’s skill from short-term performance: a quarter’s results may reflect factors unrelated to stock-picking or asset allocation. They therefore use comparison with peers as an additional signal. A manager investing in the same kinds of stocks and assets as other managers at least appears rational; one who departs from the prevailing style can instead look reckless, even when the departure is deliberate.

This reputational test creates an incentive to choose the strategy that seems rational rather than the strategy that actually is rational. Investors do not have unlimited patience, and even an excellent manager will sometimes perform poorly. A contrarian may need time for a sound strategy to show its value, but can lose investor confidence before that happens. Following the crowd thus protects a manager’s standing in the short term, even as it may frustrate the stated aim of outperforming the market.

Consequences for the Market

When managers imitate competitors, they stop relying fully on their own information and instead depend on information already reflected in others’ choices. The result is not merely a narrower set of investments: it is also a less informative market, because imitators contribute fewer distinct judgments. Stein and Scharfstein’s account therefore presents herding as a response to professional incentives, not simply as an inability or unwillingness to think independently. The very comparison that helps investors judge whether a manager appears sensible can discourage the independent decisions that might make the market collectively smarter.