Aftermarket Short Covering and the Pricing of IPOs

Björn Bartling and Andreas Park

No 16, Royal Economic Society Annual Conference 2002 from Royal Economic Society

Abstract: Investment banks legally pursue supposedly price stabilising activities in the aftermarket of IPOs. We model the offering procedure as a signalling game and analyse how the possibility of potentially profitable trading in the aftermarket influences the investment bank's pricing decision. Banks maximise the sum of both the gross spread of the offer revenue and profits from aftermarket trading. They therefore have an incentive to distort the offer price by strategically using aftermarket short covering and exercise of the overallotment option. This results either in informational inefficiencies or exacerbated underpricing, and redistribution of wealth mainly in favour of investment banks.

Date: 2002-08-29
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