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Hot Markets, Investor Sentiment, and IPO Pricing

  • Alexander Ljungqvist

    (New York University and Centre for Economic Policy Research)

  • Vikram Nanda

    (University of Michigan)

  • Rajdeep Singh

    (University of Minnesota)

We model an IPO company's optimal response to the presence of sentiment investors. "Regular" investors are allocated stock that they subsequently sell to sentiment investors. Because sentiment demand may disappear prematurely, carrying IPO stock in inventory is risky, so for regulars to break even the stock must be underpriced. The issuer still gains as the offer price capitalizes part of the regulars' expected trading gain. This resolves the empirical puzzle that issuers do not appear to price their stock aggressively in hot markets. The model generates new refutable predictions regarding the extent of long-run underperformance, offer size, flipping, and lockups.

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Article provided by University of Chicago Press in its journal Journal of Business.

Volume (Year): 79 (2006)
Issue (Month): 4 (July)
Pages: 1667-1702

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Handle: RePEc:ucp:jnlbus:v:79:y:2006:i:4:p:1667-1702
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