Does Prospect Theory Explain IPO Market Behavior?

40 Pages Posted: 3 Nov 2008  

Alexander Ljungqvist

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Research Institute of Industrial Economics (IFN)

William J. Wilhelm

University of Virginia - McIntire School of Commerce

Multiple version iconThere are 3 versions of this paper

Date Written: February 2004

Abstract

We derive a behavioral measure of the IPO decision-maker s satisfaction with the underwriter s performance based on Loughran and Ritter s (2002) application of prospect theory to IPO underpricing. We assess the plausibility of this measure by studying its power to explain the decision-maker s subsequent choices. Controlling for other known factors, IPO firms are less likely to switch underwriters for their first seasoned equity offering when our behavioral measureindicates they were satisfied with the IPO underwriter s performance. Underwriters also appear to benefit from behavioral biases in the sense that they extract higher fees for subsequent transactions involving satisfied decision-makers. Although our tests suggest there is explanatory power in the behavioral model, they do not speak directly to whether deviations from expected utility maximization determine patterns in IPO initial returns.

Keywords: Prospect theory, Behavioral finance, Initial public offerings, Underpricing

Suggested Citation

Ljungqvist, Alexander and Wilhelm, William J., Does Prospect Theory Explain IPO Market Behavior? (February 2004). NYU Working Paper No. FIN-04-006. Available at SSRN: https://ssrn.com/abstract=1294441

Alexander Ljungqvist (Contact Author)

New York University (NYU) - Department of Finance ( email )

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National Bureau of Economic Research (NBER) ( email )

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Centre for Economic Policy Research (CEPR)

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European Corporate Governance Institute (ECGI)

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Research Institute of Industrial Economics (IFN) ( email )

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William J. Wilhelm

University of Virginia - McIntire School of Commerce ( email )

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Charlottesville, VA 22904-4173
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