A Theory of IPO Underpricing, Issue Activity, and Long-Run Underperformance

40 Pages Posted: 2 Jan 2005

See all articles by Ralph Bachmann

Ralph Bachmann

Nanyang Technological University (NTU) - Division of Banking & Finance

Date Written: September 17, 2004

Abstract

We present a dynamic model of an IPO market in which firms go public to raise capital for investment. The original shareholders have inside information with respect to the quality of their firm's investment opportunities, and they decide whether to go public, how much capital to raise and invest, and how to price the IPO. Outside investors are of one of two types: some investors know and understand even the not directly observable economic incentives of the original shareholders, whereas all other investors learn about the IPO market only from the publicly observable IPO market data. Market participation by the latter investors can upset the stationary rational equilibrium and give rise to a dynamic equilibrium that is characterized by: (1) IPO underpricing, (2) underperformance of IPO shares in the long run, and (3) cyclical variations in IPO volume. Learning investors upset the stationary equilibrium not because of ex ante unreasonable beliefs, but because they fail to condition their beliefs on variables that convey only redundant information in the stationary equilibrium. The model provides a joint explanation for the three empirically documented IPO market "anomalies," and it yields a number of new testable empirical predictions.

JEL Classification: D82, D83, G31, G32

Suggested Citation

Bachmann, Ralph, A Theory of IPO Underpricing, Issue Activity, and Long-Run Underperformance (September 17, 2004). AFA 2005 Philadelphia Meetings. Available at SSRN: https://ssrn.com/abstract=642324 or http://dx.doi.org/10.2139/ssrn.642324

Ralph Bachmann (Contact Author)

Nanyang Technological University (NTU) - Division of Banking & Finance ( email )

Nanyang Avenue, S3-B1A-14
Singapore 639798
Singapore
+65 6790 5000 (Phone)
+65 6794 6321 (Fax)

Register to save articles to
your library

Register

Paper statistics

Downloads
1,247
Abstract Views
4,631
rank
15,285
PlumX Metrics