Underpricing of Initial Public Offerings in Almost Perfect Capital Markets: Experimental Evidence

The underpricing of initial public offerings is a well-documented fact of empirical equity market research. Theories explain this underpricing with market imperfections. We study three empirically relevant IPO mechanisms under almost perfect market conditions in the laboratory: a stylized book building approach, a closed book auction, and an open book auction. We report underpricing in each of these IPO mechanisms. IPO excess returns may partly be accounted for by the uncertainty regarding aftermarket behavior, but underpricing persists even in the repeated setting where uncertainty is largely removed and despite equilibrium adjustment dynamics that we observe in the data. A behavioral bias alike the disposition effect fosters IPO underpricing in our setting; we observe a market-wide impact of investors' reluctance to sell in the aftermarket at a price below the offering price.