Heterogeneous expectations, IPO Underpricing and issuing mechanism

Background: Compared with the fixed-price mechanism, the bookbuilding mechanism has not changed the Chinese IPO high underpricing. How to develop scientific and reasonable IPO pricing, and reduce the high IPO underpricing has become a major challenge for China's securities market. Methods: In this paper, using behavioral finance theory and game theory, we build the Initial public offering (IPO) pricing and underpricing models with investors’ heterogeneity based on different issuing mechanisms and provide a comparative analysis. Results: Firstly, our models show that IPO underpricing will not be eliminated by using either fixed-price or bookbuilding mechanisms, but when the investors’ heterogeneity expectation is the same, lower IPO underpricing can be obtained by the issuing of bookbuilding compared with that of fixed price. Secondly, the IPO underpricing may be larger than that under fixed price if the heterogeneity of investors under bookbuilding is larger than that under fixed price. Thirdly, the numerical analysis results provide strong support for our model. Conclusions: These findings further explains the cause of the high IPO underpricing long-standing in China.