IDEAS home Printed from https://ideas.repec.org/a/eee/reveco/v88y2023icp902-927.html
   My bibliography  Save this article

Deliberate premarket underpricing: New evidence on IPO pricing using machine learning

Author

Listed:
  • Pirayesh Neghab, Davood
  • Bradrania, Reza
  • Elliott, Robert

Abstract

We propose a nonlinear approach based on stochastic frontier and Deep Neural Networks (DNN) to estimate the pricing efficiency and the level of premarket inefficiencies for IPOs, using information available before the IPO day and without any distributional assumptions. We apply the proposed approach in the US IPO market to estimate deliberate (premarket) underpricing and find that the IPO offer prices are about 12.43% less than the estimated maximum offer prices on average. We further show that only a few determinants of the value of firms impact the pricing and deliberate underpricing of IPOs. Negative net income and EBITDA play the most important roles in determining the IPO maximum offer price, among various pricing variables. Proceeds followed by underwriter reputation negatively impact the premarket underpricing, and the IPO market activity, measured by the number of new issues, is the most important market cycle proxy that influences the premarket underpricing. We show that aftermarket mispricing is attributed more to offer size and underwriter reputation. The proposed DNN-based method is an easy to implement approach and can be used by academics and practitioners to estimate maximum offer prices and disentangle initial returns into deliberate premarket underpricing and aftermarket mispricing.

Suggested Citation

  • Pirayesh Neghab, Davood & Bradrania, Reza & Elliott, Robert, 2023. "Deliberate premarket underpricing: New evidence on IPO pricing using machine learning," International Review of Economics & Finance, Elsevier, vol. 88(C), pages 902-927.
    • Handle: RePEc:eee:reveco:v:88:y:2023:i:c:p:902-927
    DOI: 10.1016/j.iref.2023.07.008
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S1059056023002186
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.iref.2023.07.008?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Nanda, Ramana & Rhodes-Kropf, Matthew, 2013. "Investment cycles and startup innovation," Journal of Financial Economics, Elsevier, vol. 110(2), pages 403-418.
    2. Chen, Anlin & Hung, Chen Chein & Wu, Chin-Shun, 2002. "The Underpricing and Excess Returns of Initial Public Offerings in Taiwan Based on Noisy Trading: A Stochastic Frontier Model," Review of Quantitative Finance and Accounting, Springer, vol. 18(2), pages 139-159, March.
    3. Hunt-McCool, Janet & Koh, Samuel C & Francis, Bill B, 1996. "Testing for Deliberate Underpricing in the IPO Premarket: A Stochastic Frontier Approach," The Review of Financial Studies, Society for Financial Studies, vol. 9(4), pages 1251-1269.
    4. Koop, Gary & Li, Kai, 2001. "The valuation of IPO and SEO firms," Journal of Empirical Finance, Elsevier, vol. 8(4), pages 375-401, September.
    5. Allen, Franklin & Faulhaber, Gerald R., 1989. "Signalling by underpricing in the IPO market," Journal of Financial Economics, Elsevier, vol. 23(2), pages 303-323, August.
    6. Meeusen, Wim & van den Broeck, Julien, 1977. "Efficiency Estimation from Cobb-Douglas Production Functions with Composed Error," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 18(2), pages 435-444, June.
    7. Liu, Xiaoding & Ritter, Jay R., 2011. "Local underwriter oligopolies and IPO underpricing," Journal of Financial Economics, Elsevier, vol. 102(3), pages 579-601.
    8. Yung, Chris & Çolak, Gönül & Wei Wang, 2008. "Cycles in the IPO market," Journal of Financial Economics, Elsevier, vol. 89(1), pages 192-208, July.
    9. Nahata, Rajarishi, 2008. "Venture capital reputation and investment performance," Journal of Financial Economics, Elsevier, vol. 90(2), pages 127-151, November.
    10. J. Griffin & M. Steel, 2008. "Flexible mixture modelling of stochastic frontiers," Journal of Productivity Analysis, Springer, vol. 29(1), pages 33-50, February.
    11. Benveniste, Lawrence M. & Spindt, Paul A., 1989. "How investment bankers determine the offer price and allocation of new issues," Journal of Financial Economics, Elsevier, vol. 24(2), pages 343-361.
    12. Hailin Liao & Bin Wang & Tom Weyman-Jones, 2007. "Neural Network Based Models for Efficiency Frontier Analysis: An Application to East Asian Economies' Growth Decomposition," Global Economic Review, Taylor & Francis Journals, vol. 36(4), pages 361-384.
    13. Ritter, Jay R., 1987. "The costs of going public," Journal of Financial Economics, Elsevier, vol. 19(2), pages 269-281, December.
    14. Rock, Kevin, 1986. "Why new issues are underpriced," Journal of Financial Economics, Elsevier, vol. 15(1-2), pages 187-212.
    15. Yue-Cheong Chan & Congsheng Wu & Chuck Kwok, 2007. "Valuation of global IPOs: a stochastic frontier approach," Review of Quantitative Finance and Accounting, Springer, vol. 29(3), pages 267-284, October.
    16. Reber, Beat & Vencappa, Dev, 2016. "Deliberate premarket underpricing and aftermarket mispricing: New insights on IPO pricing," International Review of Financial Analysis, Elsevier, vol. 44(C), pages 18-33.
    17. Willam Greene, 2005. "Fixed and Random Effects in Stochastic Frontier Models," Journal of Productivity Analysis, Springer, vol. 23(1), pages 7-32, January.
    18. Fama, Eugene F. & French, Kenneth R., 1997. "Industry costs of equity," Journal of Financial Economics, Elsevier, vol. 43(2), pages 153-193, February.
    19. Smith, Clifford Jr., 1986. "Investment banking and the capital acquisition process," Journal of Financial Economics, Elsevier, vol. 15(1-2), pages 3-29.
    20. Stevenson, Rodney E., 1980. "Likelihood functions for generalized stochastic frontier estimation," Journal of Econometrics, Elsevier, vol. 13(1), pages 57-66, May.
    21. Greene, William H., 1990. "A Gamma-distributed stochastic frontier model," Journal of Econometrics, Elsevier, vol. 46(1-2), pages 141-163.
    22. Beat Reber & Bob Berry & Steve Toms, 2005. "Predicting mispricing of initial public offerings," Intelligent Systems in Accounting, Finance and Management, John Wiley & Sons, Ltd., vol. 13(1), pages 41-59, March.
    23. Hu, Yi & Dai, Tiantian & Li, Yong & Mallick, Sushanta & Ning, Lutao & Zhu, Baohua, 2021. "Underwriter reputation and IPO underpricing: The role of institutional investors in the Chinese growth enterprise market," International Review of Financial Analysis, Elsevier, vol. 78(C).
    24. Gompers, Paul A., 1996. "Grandstanding in the venture capital industry," Journal of Financial Economics, Elsevier, vol. 42(1), pages 133-156, September.
    25. Friesen, Geoffrey C. & Swift, Christopher, 2009. "Overreaction in the thrift IPO aftermarket," Journal of Banking & Finance, Elsevier, vol. 33(7), pages 1285-1298, July.
    26. Lerner, Joshua, 1994. "Venture capitalists and the decision to go public," Journal of Financial Economics, Elsevier, vol. 35(3), pages 293-316, June.
    27. Chahine, Salim, 2007. "Investor interest, trading volume, and the choice of IPO mechanism in France," International Review of Financial Analysis, Elsevier, vol. 16(2), pages 116-135.
    28. Aigner, Dennis & Lovell, C. A. Knox & Schmidt, Peter, 1977. "Formulation and estimation of stochastic frontier production function models," Journal of Econometrics, Elsevier, vol. 6(1), pages 21-37, July.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Martin Abrahamson, 2024. "Offer Price and Post-IPO Ownership Structure," JRFM, MDPI, vol. 17(2), pages 1-12, February.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Reber, Beat & Vencappa, Dev, 2016. "Deliberate premarket underpricing and aftermarket mispricing: New insights on IPO pricing," International Review of Financial Analysis, Elsevier, vol. 44(C), pages 18-33.
    2. Reber, Beat, 2017. "Does mispricing, liquidity or third-party certification contribute to IPO downside risk?," International Review of Financial Analysis, Elsevier, vol. 51(C), pages 25-53.
    3. Wang, Zhuqing & Wang, Xinyu & Xu, Yan & Cheng, Qiuying, 2022. "Are green IPOs priced differently? Evidence from China," Research in International Business and Finance, Elsevier, vol. 61(C).
    4. Klein, Peter G. & Wuebker, Robert & Zoeller, Kathrin, 2016. "Relationship banking and conflicts of interest: Evidence from German initial public offerings," Journal of Corporate Finance, Elsevier, vol. 39(C), pages 210-221.
    5. C. Liu & C. Y. Chung, 2013. "SEO underpricing in China's stock market: a stochastic frontier approach," Applied Financial Economics, Taylor & Francis Journals, vol. 23(5), pages 393-402, March.
    6. Marcato, Gianluca & Milcheva, Stanimira & Zheng, Chen, 2018. "Market integration, country institutions and IPO underpricing," Journal of Corporate Finance, Elsevier, vol. 53(C), pages 87-105.
    7. Yue-Cheong Chan & Congsheng Wu & Chuck Kwok, 2007. "Valuation of global IPOs: a stochastic frontier approach," Review of Quantitative Finance and Accounting, Springer, vol. 29(3), pages 267-284, October.
    8. Kamil Makieła & Błażej Mazur, 2022. "Model uncertainty and efficiency measurement in stochastic frontier analysis with generalized errors," Journal of Productivity Analysis, Springer, vol. 58(1), pages 35-54, August.
    9. Evgeny Lyandres & Fangjian Fu & Erica X. N. Li, 2018. "Do Underwriters Compete in IPO Pricing?," Management Science, INFORMS, vol. 64(2), pages 925-954, February.
    10. Cho, Jaemin & Lee, Jaeho, 2013. "The venture capital certification role in R&D: Evidence from IPO underpricing in Korea," Pacific-Basin Finance Journal, Elsevier, vol. 23(C), pages 83-108.
    11. Dorsman, André & Gounopoulos, Dimitrios, 2013. "European Sovereign Debt Crisis and the performance of Dutch IPOs," International Review of Financial Analysis, Elsevier, vol. 30(C), pages 308-319.
    12. Kamil Makieła & Błażej Mazur, 2020. "Bayesian Model Averaging and Prior Sensitivity in Stochastic Frontier Analysis," Econometrics, MDPI, vol. 8(2), pages 1-22, April.
    13. Jim Griffin & Mark Steel, 2007. "Bayesian stochastic frontier analysis using WinBUGS," Journal of Productivity Analysis, Springer, vol. 27(3), pages 163-176, June.
    14. Fouad Jamaani & Manal Alidarous, 2019. "Review of Theoretical Explanations of IPO Underpricing," Journal of Accounting, Business and Finance Research, Scientific Publishing Institute, vol. 6(1), pages 1-18.
    15. Geranio, Manuela & Mazzoli, Camilla & Palmucci, Fabrizio, 2017. "The effects of affiliations on the initial public offering pricing," International Review of Economics & Finance, Elsevier, vol. 51(C), pages 295-313.
    16. Dimovski, William & Brooks, Robert, 2008. "The underpricing of gold mining initial public offerings," Research in International Business and Finance, Elsevier, vol. 22(1), pages 1-16, January.
    17. Gholamreza Hajargasht & William E. Griffiths, 2018. "Estimation and testing of stochastic frontier models using variational Bayes," Journal of Productivity Analysis, Springer, vol. 50(1), pages 1-24, October.
    18. Bostan, Ibrahim & Mian, G. Mujtaba, 2024. "Inventor CEOs and financing of innovation: Evidence from IPOs," Journal of Banking & Finance, Elsevier, vol. 164(C).
    19. William Griffiths & Xiaohui Zhang & Xueyan Zhao, 2014. "Estimation and efficiency measurement in stochastic production frontiers with ordinal outcomes," Journal of Productivity Analysis, Springer, vol. 42(1), pages 67-84, August.
    20. William Griffiths & Xiaohui Zhang & Xueyan Zhao, 2010. "A Stochastic Frontier Model for Discrete Ordinal Outcomes: A Health Production Function," Monash Econometrics and Business Statistics Working Papers 3/10, Monash University, Department of Econometrics and Business Statistics.

    More about this item

    Keywords

    IPO; Underpricing; Deliberate underpricing; Machine learning; DNN; Offer price;
    All these keywords.

    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C45 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Neural Networks and Related Topics
    • C49 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Other
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:reveco:v:88:y:2023:i:c:p:902-927. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/620165 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.