Financial stability at risk: evidence from market overreaction and herding behaviour in developed and emerging markets

Purpose This study examines the relationships between herding behaviour, market overreaction and financial stability in developed and Brazil, Russia, India and China (BRICS) markets from 1 January 2017 to 31 December 2023. It identifies the significant differences in these phenomena across different market types and their implications for financial stability. Design/methodology/approach This study employs panel data regression, quantile regression, Granger causality tests and the Baron and Kenny mediation model to analyse the data. These methods are used to explore the extent to which herding behaviour exacerbates market overreaction and affects financial stability. Findings The results reveal that herding behaviour exacerbates short-term market overreaction, leading to increased financial instability, particularly in BRICS markets. In contrast, herding behaviour does not significantly impact intermediate-term overreactions in developed markets. The study also finds that market overreaction significantly mediates the relationship between herding behaviour and financial stability. Practical implications These findings have practical implications for policymakers. Understanding how herding behaviour and market overreaction impact financial stability can help formulate strategies to enhance market stability and mitigate systemic risks, particularly in more volatile BRICS markets. Social implications Enhanced financial stability has broad social implications, including improved investor confidence and economic growth. Policymakers can use these insights to create more stable financial environments, which can lead to more robust economic development and reduced vulnerability to financial crises. Originality/value This study provides new insights into the differential impact of herding behaviour and market overreaction on financial stability in developed and BRICS markets. By confirming the mediating role of market overreaction, this study enhances our understanding of financial market anomalies and contributes to the literature on financial stability.