A Behavioural Explanation for the Ipo Puzzles

The Basics of the Research

Article reviewed:

Iván A. Kataryniuk Di Costanzo, “A Behavioural Explanation for the IPO Puzzles”, Master Thesis CEMFI No. 0907, December 2009.

The article, “A Behavioural Explanation for the IPO Puzzles” by Iván A. Kataryniuk Di Costanzo seeks to develop a model in which the approaches of the IPO phenomenon were taken from a theorist point of view. This article explains the main issue of initial public offering (IPO) and the reason behind the phenomenon by adapting academic analysis and theories. The author stated two cases which often happen to IPO. Firstly, IPO usually issued at under-priced compared to the final price which is the price that will be traded at stock exchange on the first day. The price will increased by 12-18% commonly based on the report. This phenomenon is explained by Winner’s curse or informational cascades, which means the information given is not enough and investors acted based on emotions due to new things. Secondly, IPO often underperformed compared to the equivalent or similar company for the first three years. The reason for this is empirically studied from two approaches which are depending on a problem with the risk-adjustment of IPO’s and the perspective of behavioural finance but in the article, author focus on the behavioural finance perspective.  

To look things based on behavioural finance perspective, the author uses De Long et al. (1990) to explain the phenomenon. It explains the phenomenon by using arbitrageurs and positive feedback traders. If the market only existed with positive feedback traders, which who only look at the difference of filling price and offer price to make money, we cannot explain the underperformance of the IPO because the bubbles can be positive/negative and they cancel out in expected terms and no overvaluation will be done. So the author thinks that there must be asymmetries in the IPO process and that is short selling constraints in the very first day and presence of some degree of private information by the side of owner in order to immerse in a positive bubble.

The author insists to regulate the retail investors to short sell and allow the institutional investors (arbitrageurs) to do so. This is because institutional investors have better technology to look shares in equity lending markets and have easy access. However this proposal has difficulties in delivery of the borrowed shares and current regulatory system. Based on the view of private information by the owner, everyone assume that the owner will sell the company when he/she is able to engage in a positive bubble so achieve higher pricing. So the goal of the private information is to combine the market timing theories with the feedback traders who wants sell at higher price compared to the past.

This study focuses on the benchmark model, with asymmetric short selling constraints. Besides, this research also present a model in which short selling is possible but there is private information from the side of the owner. Other than that, the author analysed the empirical implications of the model and comparing them with the current literature about IPO’s. Lastly, it was clear in the abstract that the author stated that the model also give an overview on the decision to go public, and provides interesting indications which partly consistent with the empirical literature, while others have yet to be tested.