A Game-Theoretic Model of Underpricing and Over-Subscription in Chinese IPO's

9 Pages Posted: 28 Nov 2015

See all articles by Paul Geertsema

Paul Geertsema

University of Auckland - Department of Accounting and Finance

Helen Lu

University of Auckland - Department of Accounting and Finance

Date Written: November 26, 2015

Abstract

In Chinese A-share IPO's the bulk of available stock is allocated to investors via a lottery. Since the probability of an investor winning the lottery depends on the dollar value of deposits submitted by other investors (and vice versa), the payoff structure of participating in an IPO resembles a game. We solve a simple version of the game for the static Nash equilibrium in continuous strategies and derive the optimal IPO deposit for an arbitrary number of investors with common risk aversion within a two-moment decision model. As the number of investors grows large, the over-subscription ratio implied by our model reduces asymptotically to the ratio of expected IPO underpricing to the net cost of funding of deposits. Notably, investor risk aversion does not enter into this asymptotic solution. A data set of 1,121 Chinese A-share IPO's provides empirical support for our results.

Keywords: IPO Underpricing, Risk aversion, Game theory

JEL Classification: D81, G15, C70

Suggested Citation

Geertsema, Paul G. and Lu, Helen, A Game-Theoretic Model of Underpricing and Over-Subscription in Chinese IPO's (November 26, 2015). Available at SSRN: https://ssrn.com/abstract=2695647 or http://dx.doi.org/10.2139/ssrn.2695647

Paul G. Geertsema (Contact Author)

University of Auckland - Department of Accounting and Finance ( email )

12 Grafton Rd
Private Bag 92019
Auckland, 1010
New Zealand

Helen Lu

University of Auckland - Department of Accounting and Finance ( email )

Private Bag 92019
Auckland 1001
New Zealand

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