Uncertain Demand, Heterogeneous Expectations, and Unintentional IPO Underpricing


  • I appreciate the helpful comments of Clifford Thies, Jie Cai, session attendees at the 2003 FMA meeting, two anonymous referees, and the editor, Arnold Cowan. I am responsible for any errors that remain herein.


Distinguishing between intentional and unintentional incentives to underprice initial public offerings (IPOs), I develop sufficient conditions for the winners' curse postulated by Miller (1977) and implications for intertemporal changes in the magnitude of underpricing. Specifically, I show that unintentional underpricing (and occasional overpricing) of IPOs is a consequence of investors' heterogeneous expectations of the uncertain value of a stock when the supply is constrained and the underwriter's price discovery process only partially identifies aggregate demand. Moreover, an IPO that is oversubscribed in the premarket sale almost certainly will experience a short-term price increase in the secondary market.