FIN-01-007

Hot Markets, Investor Sentiment, and IPO Pricing

August 24, 2001

Alexander P. Ljungqvist, Vikram Nanda, and Rajdeep Singh

ABSTRACT

Our model of the initial public offering process links the three main empirical IPO ‘anomalies’ – underpricing, hot issue markets, and long-run underperformance – and traces them to a common source of inefficiency. We relate hot IPO markets (such as the 1999/2000 market for Internet IPOs) to the presence of a class of investors who are ‘irrational’ in the sense of having exuberant expectations regarding future performance. Underpricing and long-run underperformance emerge as underwriters attempt to maximize profits from the sale of equity, at the expense of these exuberant investors. Underpricing serves to compensate regular IPO investors for their role in restricting the supply of available shares and maintaining prices. The model is shown to be consistent with many aspects of the IPO process. It also generates a number of new empirical predictions.


Subject: Corporate Finance/Capital Structure and Dividend Policy; Corporate Finance/I-Banking and Venture Capital
Classification: Theoretical

Alexander P. Ljungqvist
Institution: Stern School of Business, New York University
Email: aljungqv@stern.nyu.edu
Phone: (212) 998-0304
Home Page: http://www.stern.nyu.edu/~aljungqv/

Vikram Nanda
Institution: University of Michigan Business School
Email: vnanda@umich.edu

Rajdeep Singh
Institution: University of Minnesota
Email: rajsingh@tc.umn.edu


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