Does Prospect Theory Explain IPO Market Behavior?

40 Pages Posted: 11 Nov 2008

See all articles by Alexander Ljungqvist

Alexander Ljungqvist

Stockholm School of Economics; 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 measure indicates 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. S-FI-04-03, Available at SSRN: https://ssrn.com/abstract=1297737

Alexander Ljungqvist (Contact Author)

Stockholm School of Economics ( email )

111 60 Stockholm
Sweden

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Research Institute of Industrial Economics (IFN) ( email )

Box 55665
Grevgatan 34, 2nd floor
Stockholm, SE-102 15
Sweden

William J. Wilhelm

University of Virginia - McIntire School of Commerce ( email )

Rouss & Robertson Halls, East Lawn
P.O. Box 400173
Charlottesville, VA 22904-4173
United States
434-924-7666 (Phone)
434-924-7074 (Fax)

HOME PAGE: http://gates.comm.virginia.edu/wjw9a/

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