The Naked Short Puzzle, Syndicate Conflicts and IPO Underpricing
28 Pages Posted: 1 Mar 2005
Date Written: January 2005
This paper provides a model to explain a puzzle connected with IPOs: why underwriters often create naked short positions - not covered by an over-allotment option - when share prices usually increase in the aftermarket, exposing them to loss. We focus on the economics of stabilization and naked short positions, and show how the lead underwriter's objectives can differ from those of the other underwriters. The disparity between the lead's share of stabilization profits and losses on the one hand and her share of selling concession on the other provides an explanation why she may have an interest in establishing a naked short even if the coverage of it is costly to the underwriters as a whole. Naked shorts, once established, incentivize the lead to price IPOs accurately. They could, if made a requirement by issuers, limit underpricing.
Keywords: IPO, naked short, syndicate conflicts
JEL Classification: G24
Suggested Citation: Suggested Citation