Application of the auction theory to the overpricing phenomenon in a corporate bond underwriting market

This short article demonstrates an application of price auction theory to a securities underwriting market, which is characterized by the competitive behaviours of investment houses. An investigation of newly issued Japanese straight bonds, reported in a letter by Matsui (2006), provided statistical evidence that issue yields tend to be set significantly lower than equilibrium yields. Consistent with that finding, the model presented in this letter demonstrates theoretically that increased underwriting competition reduces issue yields and that the degree of overpricing is positively correlated with the credit quality of the issuer.