Recherche
I-1)Underpricing definition:
Before going in details, presenting the explanations advanced for the short run IPO anomaly, it is logical to begin by a definition of this notion of “underpricing” to understand this short run phenomenon: Early writers that have been interested in IPO market, notably Stoll and Curley (1970), Logue (1973), Reilly (1973) and Ibbotson (1975), are […]
I-2)A persistent anomaly in time:
In the United States, at the end of the first day of trading, the shares traded on average at 18.9% above the offer price at which the company sold them (1990-2007). Underpricing has averaged 21.2% in the 1960s, 9% in the 1970s, and increasing from 7.8% in the 1980s to 14.4% in the 1990s and […]
I-3)A persistent anomaly in all countries:
Many researchers have been concentrated in studying the persistence of underpricing anomaly internationally. The underpricing phenomenon of Initial Public Offerings (IPOs) has been widely studied across different stock markets around the world and it is a persistent phenomenon all over the world. Loughran, Ritter and Rydqvist (1994)(2) documented that the underpricing anomaly exists in all […]
I-4)A persistent anomaly in all industries:
Underpricing is also persistent for all the industries: automobile, banks, chemicals, construction, financial services, food and beverages, industrial, machinery, media, pharmaceutical and health, software, technology, telecommunications, transport and logistics … Every firm, which decides to go public, faces the phenomenon of underpricing, the price of shares the firm sells tends to jump substantially on the […]
II- Theoretical explanations of short run underpricing: A literature review
The research effort aimed at explaining the short run anomaly of the IPO market has provided numerous analytical advances and empirical insights, and a large list of explanations has been offered. Ibbotson (1975) is the first who offered a list of possible explanations for underpricing, many of which were formally explored by other authors in […]
II-1)Asymmetric information:
The key parties to an IPO transaction are the issuing firm, the bank underwriting and marketing the deal, and investors. Asymmetric information models assume that one of these parties knows more than the others. Page suivante : II-1-1)The issuer is more informed than the investors: Welch (1989) and others assume that the issuer is better […]
II-1-1)The issuer is more informed than the investors: Welch (1989) and others assume that the issuer is better informed about its true value.
* The theory of signalling; Firm quality: The high quality issuers may attempt to signal their quality and their true value, and to distinguish themselves from the pool of low quality issuers, they voluntarily sell their shares at a lower price than the market beliefs. They leave deliberately money on the IPO table to deter […]
II-1-2)The investors are the most informed:
We are in the case of investors that are more informed than the other parties about the demand, the price they are willing to pay to acquire the IPO stocks, … * Information Revelation Theories: To reduce this informational asymmetry, issuers tend to hire underwriters and to use a “Bookbuilding mechanism”. This common practice of […]
II-2)Symmetric information:
There are some theories and explanations advanced by a great number of researchers that do not rely on asymmetric information, this theory that has been very popular among academics and practitioners for decades and that has been considered as the most relevant and convincing explanation to the short run IPO anomaly. There are some researchers […]
II-2-1)Risk premium:
Let’s begin by the risk premium explanation. Because the hot market can end prematurely, the sentiment demand may cease and then we face a market crashing, carrying IPO stocks in inventory is risky. Ljungqvist, Nanda and Singh (2003) in their article: “Hot market, investor sentiment and IPO pricing” argue that underpricing emerges as fair compensation […]
II-2-2)Characteristics of the Initial Public offering
* Risk: Risk can reflect either technological or valuation uncertainty. Loughran and Ritter (2004) use many measures of risk: the natural logarithm of the assets and the natural logarithm of the sales which reflect the issuing firm size and then a risk related to valuation uncertainty, internet and tech dummy variables which reflect technological uncertainty […]
II-2-3)Lawsuit avoidance: legal liability
Lawsuits are obviously costly, not only directly: damages, legal fees, diversion of management time, etc, but also in terms of the potential damage to their reputation capital. Litigation-prone investment banks may lose the confidence of their regular investors, while issuers may face a higher cost of capital in future capital issues. The basic idea of […]
II-2-4)Underpricing as a substitute of marketing expenditures:
Habib and Ljungqvist (2001) argue that underpricing is a substitute for costly marketing expenditures. Using a data set of IPOs from 1991 to 1995, Habib and Ljungqvist report that an extra dollar left on the table reduces other marketing expenditures by a dollar. On the first sight, underpricing seems to be just a substitute for […]
II-2-5)Internet Bubble:
One popular related explanation for the high and severe underpricing of 65% during the Internet bubble (1999-2000) for the U.S IPOs, a peak never reached before in the U.S IPO market, is that underwriters could not justify a higher offer price on Internet IPOs. Even if these firms have a high potential of profitability in […]
II-2-6)Price stabilization and partial adjustment:
Recent studies have also documented the impact of public information. They find a positive link between the “market conditions” prevailing at the time of an offering which represent public information and its subsequent initial return. Favourable market conditions predict higher underpricing and vice-versa. Derrien and Womack (2003) show that the initial returns on IPOs in […]
Section 2- Behavioral explanations
Introduction: Short run IPO anomaly may be the most controversial area of IPO research. The research effort has provided numerous analytical advances and empirical insights trying to explain the first day price run up. Many explanations were introduced and studied, but all these theories are unlikely to explain the persistent pattern of high initial returns […]
I- Definitions:
The behavioral approach asserts the presence of “irrational” investors, also called “sentiment” investors or “noise traders” whose investment decisions, choices, etc, are conducted by feelings and emotions and based on sentiment which plays a major role in their decisions. Before going more in the details, it is reasonable to begin by presenting some definitions of […]
I-1)The sentiment’s notion:
The sentiment represents the anticipations of the investors that are not justified by the fundamental. The notion of sentiment characterizes the presence of irrational investors who show undue interest in an investment opportunity, for example for IPOs, and who are irrationally exuberant, over optimistic and over enthusiastic about an investment. This over optimism and over […]
I-2)Hot IPO market’s phenomenon:
As we said before, by their nature the Initial Public Offerings are very sensitive to the state of mind of the investors and to the investor sentiment. Another characteristic is very important and which ensues of the first characteristic: the Initial Public Offering market is highly cyclical. The cyclical nature of this market has sparked […]
I-3)Investors typology:
Many empirical researches examining IPO allocations focus on the distinction between types of investors: institutional investors and individual or retail investors. Institutional investors are different from retail investors, in that institutions are better informed and more important clients. The evidence to date suggests that where bookbuilding is used, institutional investors receive preferential allocations. They are […]
II- Literature review of behavioral explanations:
As I said before, the tendency of behavioral approach and investor sentiment is not a new field not again discovered, the investor sentiment was introduced earlier in the 1990’s by Welch who presented the informational cascade theory. But the Behavioral Approach has sparked the academics’ attention, has intrigued more and more researchers and has taken […]
II-1)Informational cascades:
If potential investors pay attention not only to their own information about a new issue, but also to whether other investors are purchasing or not and they attempt to judge the interest of other investors, according to Welch (1992)(15), bandwagon effects or also known as information cascades may develop: Later investors can condition their bids […]
II-2)The prospect theory:
Prospect theory, developed by Kahneman and Tversky (1979), asserts that people focus more on changes in their wealth compared to the level of their wealth. Loughran and Ritter (2002) apply prospect theory of Kahneman and Tversky (1979) to IPO market to argue that issuers are more tolerant of excessive underpricing and that they accept underpricing […]
II-3)Investor sentiment by Ljungqvist, Nanda and Singh (2004):
We can say that the importance of investor sentiment was introduced and analyzed in the context of the underpricing phenomenon for the first time by Ljungqvist, Nanda and Singh (2004) in their article “Hot markets, Investor sentiment and IPO pricing”. The work of these authors is considered the first paper to model an IPO company’s […]
II-4)The use of Grey Market Data:
Cornelli, Goldreich and Ljungqvist (2004) try to take advantage of the existence of a grey market in Europe to construct a model on European Initial Public Offerings to look at whether the presence of sentiment investors affects prices in the post-IPO market and whether investors’ sentiment can explain and be considered as a driver and […]
II-5)The use of market conditions to value investor’s sentiment:
François Derrien (2003) explores the impact of investor sentiment on the pricing and aftermarket behaviour of IPOs, using a sample of 62 initial public offerings realized on the French stock exchange between 1999 and 2001. He tests a model in which the first day closing price of IPOs and then initial returns and underpricing are […]
II-6)Discount on closed-end funds as proxy for investor sentiment:
The proxies used in empirical works investigating in short run IPO anomaly to value the investor sentiment and to measure its impact on underpricing anomaly are numerous. One of the most important proxies often used by researchers is the discount on closed-end funds. The choice by many authors of the discount on closed-end funds as […]
II-7)Other proxies and empirical results:
The list of proxies used by researchers to value investor sentiment and to study its impact on underpricing anomaly is very long. I presented the most important proxies in the previous paragraphs: grey market prices, market conditions, demand submitted by individual investors and discounts on closed-end funds. In the present paragraph, I try to give […]
Section 3- The model and empirical implications
Introduction: The effect of sentiment investors has been advocated particularly strongly for the Initial Public Offerings’ patterns, since by definition, IPO firms have no prior share price history and tend to be young, immature, and relatively informationally opaque. So they are very sensitive to the state of mind of the investors and to investors’ feelings […]
I- The model and explanatory variables:
Page suivante : I-1)The model:Retour au menu : Investor Sentiment and Short Run IPO Anomaly: A Behavioral Explanation of Underpricing