Keywords: Liquidity, IPO, asset pricing, market microstructure
Abstract: I present a fully-rational symmetric-information model of an IPO, and a dynamic imperfectly competitive model of
trading in the IPO aftermarket. The model helps to explain IPO underpricing, underperformance, and why share
allocations favor large institutional investors. In the model, underwriters need to sell a fixed number of shares
at the IPO or in the aftermarket. To maximize revenue and avoid selling into the aftermarket where they can be
exploited by large investors, underwriters distort share allocations towards investors with market power, and set
the IPO offer price below the aftermarket trading price. Large investors who receive IPO share allocations
sell them slowly afterwards to reduce their trade's price-impact. This curtails the shares that are available to small
price-taking investors, causing them to bid up prices and bid down returns. In some simulations, the distorted share
allocations and slow unwinding behavior generate post-IPO return underperformance that persists for several years.
Full paper (518 KB PDF)
| Full Paper (Screen Reader Version)
Home | FEDS | List of 2006 FEDS papers
To comment on this site, please fill out our feedback form.
Last update: April 3, 2006