The John M. Olin Center

Paper Abstract

587. Atanu Saha & Allen Ferrell, An Asymmetric Payoff-Based Explanation of IPO "Underpricing," 05/2007.

Abstract: The widely studied phenomenon of underpricing of new issues of common stock can be explained by underwriters’ payoff asymmetry. Under uncertain investors’ demand for a new issue, the underwriter’s downside risk if he overestimates demand can be significantly larger than the upside potential when he underestimates demand. To protect himself from the large downside risk of overestimating demand, the underwriter rationally chooses a lower offer price than he would have in the absence of demand uncertainty.

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