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Short selling restrictions in 2005–2009 in Indian market and underpricing of initial public offerings

Tanya Gulati (), S. K. Bose and Supriyo Roy
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Tanya Gulati: Birla Institute of Technology, Mesra
S. K. Bose: Birla Institute of Technology, Mesra

Journal of Economics and Finance, 2017, vol. 41, issue 1, 116-135

Abstract: Abstract Most research explains underpricing of initial public offerings (IPOs) as the rational response of investors to the valuation uncertainty and the existence of informational friction in the IPO market. In contrast, Miller (1977) demonstrates that irrational sentiments of optimistic investors lead to high underpricing which pessimistic investors are unable to correct due to short selling constraints. Using first day flipping ratio and the trading ratio as proxies for divergence of opinion, we provide evidence consistent with Miller (1977) from Indian market that the greater divergence of opinion among investors results into higher underpricing. Previous research is not unanimous on proxies for short selling constraints and also do not control for the cross-sectional differences in the severity of constraints. We test Miller’s hypothesis in a market that faced prohibitive regulatory restrictions on short selling. We also control for the period when constraints are marginally relaxed. Our findings provide more robust evidence. Our results suggest that short selling restrictions affect market efficiency adversely; there could still be other forces at play. Market regulators should take steps to facilitate short selling instead of restricting it.

Keywords: IPOs; Investor sentiments; Divergence of opinion; Underpricing; Short selling; Valuation uncertainty; JEC Classification; G12; G14; G28 (search for similar items in EconPapers)
Date: 2017
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Handle: RePEc:spr:jecfin:v:41:y:2017:i:1:d:10.1007_s12197-015-9336-4