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Why are auctioned based ipos underpriced

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					Why are auction based
   IPOs underpriced?

        Panos Patatoukas
Motivation and Research
Question
   The underpricing phenomenon of traditional IPOs is
    a well established fact in the finance literature.
   But what about auction based IPOs?
   In theory the clearing price of a well designed
    auction is virtually equal to the market price so the
    first day return should be zero and underpricing non
    existent.
   But in reality auction offerings are not “underpricing
    free”!
   Why?
Summary of results
   My simple two-step experimental design yields
    results consistent with auction based IPOs being
    underpriced when information asymmetry is high.
   It also accommodates for no underpricing when
    information asymmetry is low.
   Further, my experimental setting predicts that high
    underpricings are accompanied by high trading
    volume, price volatility and bid ask spread
Pros and Cons of an
experimental design
   Pros: the experiment allows me to investigate both the pricing
    of an IPO and the aftermarket performance, volatility and
    trading volume isolating the effect for example of price
    support, underwriter/ issuer’s liability concerns, flipping,
    marketing events etc.
   Cons: To the extent that my experimental design
    unreasonably abstracts from reality any results obtained
    should be cautiously considered.
Auction theory Background
   The auction literature suggests that the pure common value multi unit
    auction setting is susceptible to underpricing.
   Further, the magnitude of the underpricing is a function of the information
    asymmetry among bidders.
   Introduce the winner’s curse idea in the multi unit auction setting.
   Intuition: If the bidder has a positive probability of influencing the price then
    he has an incentive to shade his bid.
   I model the auction IPO, as a multi unit uniform price auction with pure
    common values in which each bidder receives a private signal for the value
    of a unit of stock and accordingly submits his demand schedule in the form
    of multiple sealed bids.
Simple Experimental Design
   For the auction IPO I adopt the mechanism used in the US; a sealed
    bid, uniform (descending) market clearing price auction in which bidders
    participate with multiple bids
   The SEC allows the auctioneer-investment banker to provide the
    preliminary results of the auction in the form of private guidance to
    (institutional) bidders.
   The market clearing price (stop out price) is the highest price at which
    the aggregated demand at least equals the supply.
   In the post issue market the winning bidders are allowed to trade their
    allocations and both winning and losing bidders are allowed to
    participate. The post IPO market is designed as an open cry double
    auction.
   My experimental design allows for two scenarios, high and low
    information asymmetry, corresponding to the low and high precision (ε)
    of the bidders’ privately received signals.
Hypotheses
My simple experimental setting provides a realistic
reflection of the auction based IPO setting in the US
and allows me to test the following two hypotheses:
 H1: Auction based IPOs can be underpriced and the
   underpricing is more likely to surface when the
   information asymmetry is high (low signal precision).
 H2: The trading volume and price volatility is high
   (low) when the information asymmetry is high (low);
   high underpricings are followed by high TV and PV
Experimental results: Overview
Table1: Overview of all treatments


                                                     Round 1                                Round 2


                                     low precision         high precision   low precision             high precision

Auction price                             14                     12              15                        17

First day close                           16                    12.1            16.2                       17

True value                                16                     12              16                        17

Pro rata                                82.47%                 61.07%          67.80%                    64.52%

First day return                        14.29%                 0.83%           8.00%                      0.00%

Underpricing                            14.29%                 0.00%           6.70%                      0.00%

Volume                                    56                     43              57                        44

Trading time (in sec.)                   200                    200             180                        150

Volatility                              0.623                  0.109           0.441                      0.745

Average Bid Ask Spread                  2.543                  0.680           1.807                      1.478
Experimental results
Round 1, low signal precision
Experimental results
Round 1, low signal precision

                                  First day of trading
                          Round 1 High Information Asymmetry

17.5
  17
16.5
  16
15.5
  15
14.5
  14
13.5
  13
       0

           44

                45

                     45

                          45

                               69

                                    73

                                         73

                                              73

                                                   73

                                                        135

                                                              137

                                                                    141

                                                                          141

                                                                                141

                                                                                      163

                                                                                            168

                                                                                                  186

                                                                                                        198
                                                    price
Experimental results
Round 1, high signal precision
Experimental results
Round 1, high signal precision


                                 First day of trading
                         Round 1 Low Information Asymmetry

   14.5
    14
   13.5
    13
   12.5
                                                                                                    price
    12
   11.5
    11
   10.5
    10
                                 9

                                        3

                                               4

                                                      0

                                                             1

                                                                    4

                                                                           6

                                                                                  6

                                                                                         1

                                                                                                0
          40

               62

                    68

                         85
     0




                              10

                                     13

                                            13

                                                   14

                                                          15

                                                                 15

                                                                        15

                                                                               16

                                                                                      17

                                                                                             18
Experimental results
Round 2, low signal precision
Experimental results
Round 2, low signal precision

                                 First day of trading
                         Round 2 High Information Asymmetry

   17.5
    17
   16.5
    16
   15.5
    15
   14.5
    14
   13.5
    13
                                                                    2

                                                                           0

                                                                                  4

                                                                                         6

                                                                                                9
          35

               43

                    43

                         43

                              43

                                   66

                                        72

                                             81

                                                  83

                                                       99

                                                            99
     0




                                                                 11

                                                                        13

                                                                               14

                                                                                      14

                                                                                             15
                                                  price
Experimental results
Round 2, high signal precision
Experimental results
Round 2, high signal precision

                                 First day of trading
                         Round 2 Low Information Asymmetry

   18.5
    18
   17.5
    17
   16.5
    16
   15.5
    15
   14.5
    14
          29

               29

                    29

                         29

                              29

                                   29

                                        29

                                             57

                                                  63

                                                          69

                                                               73

                                                                    74

                                                                         82

                                                                              92

                                                                                   93

                                                                                        99
      0




                                                  price
Conclusions
   This paper adopts a simple model of pure common values
    with private affiliated signals in the setting of multi unit sealed
    bid auctions & provides experimental evidence that auction
    based IPOs can be significantly underpriced when information
    asymmetry is high.
   High underpricings are accompanied by high trading volume,
    price volatility and bid-ask spread.
   If the current mechanism adopted for the auction IPOs is
    prone to underpricing then the blame is not on the investment
    bankers that carry out the auction offerings, but on the
    structure of the “game” that delivers the underpricing.
   The quest for the most efficient IPO mechanism has begun...

				
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