An Asymmetric Payoff-Based Explanation of IPO 'Underpricing'

23 Pages Posted: 17 Aug 2007

See all articles by Atanu Saha

Atanu Saha

Compass Lexecon

Allen Ferrell

Harvard Law School; European Corporate Governance Institute (ECGI)

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

Saha, Atanu and Ferrell, Allen, An Asymmetric Payoff-Based Explanation of IPO 'Underpricing' (June 1, 2007). Harvard Law and Economics Discussion Paper No. 587, Available at SSRN: https://ssrn.com/abstract=991917 or http://dx.doi.org/10.2139/ssrn.991917

Atanu Saha

Compass Lexecon ( email )

New York, NY
United States

Allen Ferrell (Contact Author)

Harvard Law School ( email )

Griswold 303 1525 Massachusetts Avenue
Cambridge, MA 02138
United States
(617) 495-8961 (Phone)
(617) 495-1110 (Fax)

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

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