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Please use this identifier to cite or link to this item: http://hdl.handle.net/2451/26987

Title: Does Prospect Theory Explain IPO Market Behavior?
Authors: Ljungqvist, Alexander
Wilhelm, William J. Jr.
Keywords: Prospect theory
Behavioral finance
Initial public offerings
Underpricing
Issue Date: 24-Feb-2004
Series/Report no.: S-FI-04-03
Abstract: We derive a behavioral measure of the IPO decision-maker’s satisfaction with the underwriter’s performance based on Loughran and Ritter’s (2002) application of prospect theory to IPO underpricing. We assess the plausibility of this measure by studying its power to explain the decision-maker’s subsequent choices. Controlling for other known factors, IPO firms are less likely to switch underwriters for their first seasoned equity offering when our behavioral measure indicates they were satisfied with the IPO underwriter’s performance. Underwriters also appear to benefit from behavioral biases in the sense that they extract higher fees for subsequent transactions involving satisfied decision-makers. Although our tests suggest there is explanatory power in the behavioral model, they do not speak directly to whether deviations from expected utility maximization determine patterns in IPO initial returns.
URI: http://hdl.handle.net/2451/26987
Appears in Collections:Financial Institutions

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