A theory of underwriters’ risk management in a firm-commitment initial public offering

A theory of underwriters’ risk management in a firm-commitment initial public offering A cynosure of the academic literature relating to initial public offerings (IPOs) is the question of why they are “mispriced” so frequently. The large and growing literature addressing this question is evidence as to its intractability. This paper develops a theory of underwriters’ behavior suggesting that they will exploit their private information to minimize the bilateral risks to themselves of firm-commitment IPOs. That minimization may cause them to knowingly underprice the issue. The main result in this paper is based, in part, on the premise that the random character of the investors’ demand for shares in the secondary market, given the spread, is governed by an estimable conditional probability distribution. The underwriters exploit their private knowledge of that probability distribution to influence the number of shares in the offering in such a way as to minimize their expected loss function. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Quantitative Finance and Accounting Springer Journals

A theory of underwriters’ risk management in a firm-commitment initial public offering

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Publisher
Springer Journals
Copyright
Copyright © 2014 by Springer Science+Business Media New York
Subject
Finance; Corporate Finance; Accounting/Auditing; Econometrics; Operation Research/Decision Theory
ISSN
0924-865X
eISSN
1573-7179
D.O.I.
10.1007/s11156-014-0466-0
Publisher site
See Article on Publisher Site

Abstract

A cynosure of the academic literature relating to initial public offerings (IPOs) is the question of why they are “mispriced” so frequently. The large and growing literature addressing this question is evidence as to its intractability. This paper develops a theory of underwriters’ behavior suggesting that they will exploit their private information to minimize the bilateral risks to themselves of firm-commitment IPOs. That minimization may cause them to knowingly underprice the issue. The main result in this paper is based, in part, on the premise that the random character of the investors’ demand for shares in the secondary market, given the spread, is governed by an estimable conditional probability distribution. The underwriters exploit their private knowledge of that probability distribution to influence the number of shares in the offering in such a way as to minimize their expected loss function.

Journal

Review of Quantitative Finance and AccountingSpringer Journals

Published: Jul 17, 2014

References

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