ABSTRACT
The empirical findings of positive average initial returns on initial public offerings (IPOs) has often been associated with the “underpricing” phenomenon. This chapter discusses investors’ expectations in the IPO market and the implications of the model. It outlines the data and methodology, and discusses the empirical findings. Investors’ expectations of oversubscription do have an impact on the actual rate of over-subscription. Such investors’ expectations are then self-fulfilling, since oversubscription would induce the investors to demand the stock when it is traded, at least in the first couple of days. This model of investors’ expectations predicts positive average initial returns on IPOs for both bullish and bearish market conditions. Similarly, the average volatility relatives for both the bull- and bear-market portfolios are expected to decline rapidly from the initial value of 1.0 in the aftermarket as investors’ expectations about market values converge, given the information that is revealed.
