Testing Theories of Underpricing
The previous chapter provides an extensive review of the main theories so far proposed to explain underpricing. The primary “orthodox” explanations — adverse selection, principal-agent relationships, and signalling by issuers — all suggest that underpricing arises as a rational, equilibrium response to some important informational asymmetry between market participants. Additionally, some competing “heterodox” explanations, such as those proposed by Benveniste and Spindt (1989) and Welch (1992), also posit differentially informed agents to explain this puzzling phenomenon. Given the large number of rigorous, well specified explanations for underpricing, one wonders which explanation comes closest to the truth. This question is the subject of this chapter.
KeywordsInitial Public Offering Investment Bank Previous Chapter Informed Trading Initial Return
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