Are Investors Rational When Valuing Loss Firms?
Forthcoming in Journal of Behavioral Finance
31 Pages Posted: 14 Nov 2016 Last revised: 20 Nov 2016
Date Written: September 29, 2016
This paper examines whether high valuation of loss firms really exists and can be explained by behavioral factors. This valuation may originate from irrational behavior of optimistic investors who prefer lottery-like stocks, or from rational expectations of firms’ profitability. Using a sample of small Canadian firms going public, we show that both individual investors and underwriters price loss firms higher than profit firms, everything being equal. Post-IPO three-year underperformance does not differ statistically between loss and profit firms. Investors thus apparently behave irrationally for all firms, but their irrationality does not seem greater for loss firms.
Keywords: valuation, loss firms, irrational behavior, IPO, lottery stock
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