Hot Markets, Investor Sentiment, and IPO Pricing

51 Pages Posted: 2 Nov 2003

See all articles by Alexander Ljungqvist

Alexander Ljungqvist

Centre for Economic Policy Research (CEPR); Swedish House of Finance; European Corporate Governance Institute (ECGI)

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 3 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 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)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

European Corporate Governance Institute (ECGI)

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

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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