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Hot Markets, Investor Sentiment, and IPO Pricing

51 Pages Posted: 2 Nov 2003  

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)

Rajdeep Singh

University of Minnesota - Twin Cities - Carlson School of Management

Vikram K. Nanda

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics

Multiple version iconThere are 5 versions of this paper

Date Written: November 6, 2003

Abstract

We model an IPO company's optimal response to the presence of sentiment investors and short sale constraints. Given regulatory constraints on price discrimination, the optimal mechanism involves the issuer allocating stock to 'regular' institutional investors for subsequent resale to sentiment investors, at prices the regulars maintain by restricting supply. Because the hot market can end prematurely, carrying IPO stock in inventory is risky, so to break even in expectation regulars require the stock to be underpriced - even in the absence of asymmetric information. However, the offer price still exceeds fundamental value, as it capitalizes the regulars' expected gain from trading with the sentiment investors. This resolves the apparent paradox that issuers, while shrewdly timing their IPOs to take advantage of optimistic valuations, appear not to price their stock very aggressively. The model generates a number of new and refutable empirical predictions regarding the extent of long-run underperformance, offer size, flipping, and lock-ups.

Keywords: Initial public offerings, hot issue markets, behavioural finance, long-run performance

JEL Classification: G32, G24, G14

Suggested Citation

Ljungqvist, Alexander and Singh, Rajdeep and Nanda, Vikram K., Hot Markets, Investor Sentiment, and IPO Pricing (November 6, 2003). AFA 2004 San Diego Meetings; Twelfth Annual Utah Winter Finance Conference; Texas Finance Festival. Available at SSRN: https://ssrn.com/abstract=282293 or http://dx.doi.org/10.2139/ssrn.282293

Alexander Ljungqvist (Contact Author)

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

Stern School of Business
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New York, NY 10012-1126
United States
212-998-0304 (Phone)
212-995-4220 (Fax)

HOME PAGE: http://pages.stern.nyu.edu/~aljungqv

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Research Institute of Industrial Economics (IFN) ( email )

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

Rajdeep Singh

University of Minnesota - Twin Cities - Carlson School of Management ( email )

19th Avenue South
Minneapolis, MN 55455
United States
612-624-1061 (Phone)
612-626-1335 (Fax)

HOME PAGE: http://umn.edu/~rajsingh

Vikram K. Nanda

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics ( email )

2601 North Floyd Road
P.O. Box 830688
Richardson, TX 75083
United States

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