Does Prospect Theory Explain IPO Market Behavior?




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    • *Ljungqvist is from the New York University Stern School of Business and the Centre for Economic Policy Research, London, and Wilhelm is from the University of Virginia McIntire School of Commerce and the Oxford University Saïd Business School. Thanks for helpful comments go to Mike Cliff, Robert Daines, David Denis, Espen Eckbo, Miguel Ferreira, David Hirshleifer, Laurie Krigman, Jay Ritter, Ben Ross, Robert Stambaugh (the editor), Jeff Wurgler, an anonymous associate editor, an anonymous referee, and seminar participants at the Colloquium on Behavioral Finance at the NYU School of Law, Cornell University, the London School of Economics, the University of Oxford, Michigan State University, and Lisbon University. We gratefully acknowledge the contribution of Thomson Financial for providing broker recommendations data, available through the Institutional Brokers Estimate System. These data have been provided as part of a broad academic program to encourage earnings expectations research. All errors are our own.


We derive a behavioral measure of the IPO decision-maker's satisfaction with the underwriter's performance based on Loughran and Ritter (2002) and assess its ability to explain the decision-maker's choice among underwriters in subsequent securities offerings. Controlling for other known factors, IPO firms are less likely to switch underwriters when our behavioral measure indicates they were satisfied with the IPO underwriter's performance. Underwriters also extract higher fees for subsequent transactions involving satisfied decision-makers. Although our tests suggest that the behavioral model has explanatory power, they do not speak directly to whether deviations from expected utility maximization determine patterns in IPO initial returns.