Hot Markets, Investor Sentiment, and IPO Pricing

Market States and Initial Returns: Evidence from Taiwanese IPOs

“…The prior literature indicates that the auditor's attestation can reduce information asymmetry between issuers and investors, and the employment of a prestigious auditor may be interpreted by investors as a positive signal of issue value, leading to less underpricing of IPOs (Grinblatt and Hwang 1989;Hogan 1997;Welch 1989). Ljungqvist et al (2006) suggest that initial returns of IPOs are different at different market states (hot or cold issuing market), and they find that the extent of underperformance relative to the offering price increases the issuing firm's bargaining power vis-à-vis that of the underwriter. According to Ljungqvist et al (2006), we expect that the auditor's reputation can vary with different market states.…”

“…In this study we propose that different patterns of factors affect the initial returns under different market states. The difference between our study and that of Ljungqvist et al (2006) is that they take the investor sentiment and market momentum as proxies for market states. In our study, however, we modify Pagan and Sossounov's (2003) approach to separate the market states and also take Cooper et al's (2004) approach 2 to check the robustness of empirical results.…”

“…Unlike most of the relevant literature, this paper is more concerned with the different affecting patterns of the determinants of initial returns under various market states (e.g., how the auditor reputation affects IPO initial returns under various states). These affecting patterns provide investors with more important insights, for example, according to Ljungqvist et al (2006), the extent of underperformance relative to the offer price increases the issuing firm's bargaining power vis-à-vis that of the underwriter, and due to the hesitative purchasing intentions of investors in the range-bound markets, prestigious auditors employed by issuers may effectively reduce the asymmetric information of financial reports between issuers and investors. In this way, if the auditor reputation effect is stronger under the range-bound market, the issuing firm could hire prestigious auditors to reduce the asymmetric information of financial reports between issuers and investors under range-bound market.…”

“…First, Ljungqvist et al (2006) suggest that the factors affecting the initial returns and long-run performance under different market states are asymmetric, for example, the gray market price has a better forecasting effect when investors are overoptimistic (as in bullish market states). In this study we propose that different patterns of factors affect the initial returns under different market states.…”

“…Third, prior studies find that investor investment behavior is affected by market states (e.g., Cooper et al 2004;Huang 2006;Lee et al 2002;Ljungqvist et al 2006). Lee et al (2002) argue that investor sentiment is associated with different market states and hence market states can affect the investor's investment decision.…”