A market microstructure explanation of IPOs underpricing
In a typical IPO game with first-price auctions, we argue that risk-averse investors always underbid in equilibrium because of subjective interpretations of the firm' communication about its actual value and resulting risk aversion about the likelihood of facing investors with higher valuations. We show that the noisier the investors' inferences of the firm' value (in the sense of first-order stochastic dominance) the higher the underbidding level. Our finding is independent of winner's curse effects and possible irrationality, and allows for a testable theory.
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- Leite, Tore, 2005. "Returns to sentiment investors in IPOs," Economics Letters, Elsevier, vol. 89(2), pages 222-226, November.
- Rock, Kevin, 1986. "Why new issues are underpriced," Journal of Financial Economics, Elsevier, vol. 15(1-2), pages 187-212.
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