An Asymmetric Payoff-Based Explanation of IPO 'Underpricing'
23 Pages Posted: 17 Aug 2007
Date Written: June 1, 2007
Abstract
The widely studied phenomenon of underpricing of new issues of common stock can be explained by underwriters' payoff asymmetry. Under uncertain investors' demand for a new issue, the underwriter's downside risk if he overestimates demand can be significantly larger than the upside potential when he underestimates demand. To protect himself from the large downside risk of overestimating demand, the underwriter rationally chooses a lower offer price than he would have in the absence of demand uncertainty.
Keywords: ipo underpricing, underwriter, IPO, uncertainty
JEL Classification: D82, G24, G32, K22
Suggested Citation: Suggested Citation
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