Introduction:
The effect of sentiment investors has been advocated particularly strongly for the
Initial Public Offerings’ patterns, since by definition, IPO firms have no prior share price
history and tend to be young, immature, and relatively informationally opaque. So they are
very sensitive to the state of mind of the investors and to investors’ feelings and beliefs. A
large literature over the past decades, both theoretical and empirical, has attributed the IPO
pattern and the short run IPO puzzle to the presence of this type of investors.
The works of researchers who are interested in the behavioral approach and in the investor
sentiment explanation to clarify the short run IPO puzzle and to understand the IPO
underpricing anomaly are numerous. The list is long and is in continuously growth.
I presented in the previous paragraphs the most important studies and papers that have
considered the sentiment explanation and the investor’s behaviour as the most convincing and
relevant driver and determinant of IPO underpricing. I presented the application of the
behavioral and sentiment approach to clarify and to understand the IPO patterns by numerous
researchers to shed light on the importance of the sentiment investors in the IPO market.
I continue in the same direction of the behavioral approach and the investor sentiment
explanation to the short run IPO puzzle, believing in the relevance of this explanation to
clarify and to understand the underpricing phenomenon and in the importance of sentiment
investors in the IPO market to explain its anomalies. I presume that there are periods when
capital providers (individual and institutional investors) become irrationally enthusiastic about
new investment opportunities. In this thesis, we are in the case of the new Initial Public
Offerings. They become irrationally overly optimistic about the IPO market. This over
optimism is based on the favourable recent history of the IPO market and the positive initial
returns recently observed for the new issues. These sentiment investors project this positive
tendency on the recent future, believing that the IPO market will continue in the same
direction in the recent future for sure. This period is known as “Hot IPO market”.
The investors’ exuberance translates into periods of high demand for Initial Public Offerings,
called “sentiment demand” since it is based on sentiment and beliefs. It is far from a perfectly
rational demand based on fundamentals, and these sentiment investors are willing to pay
higher prices to have IPO shares. As I presented in a previous paragraph, the IPO market is
cyclical. There are periods of “hot market”, but there are also periods of “cold IPO market”
and sentiment investors become overly pessimistic about IPOs.
There are two types of investors: there are individual or retail investors and institutional
investors who are more informed and important clients. A question may arise: what type of
investors is driving first day closing prices and the underpricing anomaly?
The empirical works and studies investigating in IPO issue activity and particularly in the
short run IPO anomaly, using the “traditional explanations” based on the asymmetric or
symmetric theories, or using the behavioral approach and the sentiment explanation, draw
numerous and different conclusions.
The biggest limitation is that none conduct a comprehensive analysis that evaluates all of the
explanations in a systematic manner. None try to present in the same model all the
explanations: asymmetric, symmetric and behavioral, to determine which is the most relevant
and convincing to explain the short run IPO puzzle, and none try to distinguish between the
sentiment of the two types of investors: individual and institutional, to verify which type of
investors exactly is driving the underpricing anomaly.
In this study, an effort to regroup the most important explanations that have been advanced in
the same model to determine which of these explanations characterizes best the data in the
context of a unified framework and model. I introduce the three theories:
Asymmetric information
Symmetric information, and
Behavioral approach.
And since there are two types of investors in the IPO market: individual and institutional
investors, one of the goals of this study, is to identify which type is driving the first day
closing prices and underpricing by distinguishing between the individual investors’ sentiment
and the institutional investors’ sentiment.
To this end, I use direct measure of sentiment for the two types of investors and this
represents another contribution of this work.
The aim in this thesis is to show how sentiment investors and their irrationally overly
optimism can lead to a first day price run up and therefore to underpricing, and can explain
this short run anomaly with a distinction between the two types of investors in the IPO market
to clarify and to understand which type is more conducting the short run IPO puzzle, and
using a direct measure of sentiment for each category of investors: the investor sentiment
index.