Risk Proxies and IPO Underpricing : An Empirical Investigation

This paper is motivated by the apparent belief that risk and uncertainty surrounding an Initial Public Offering (IPO) have significant impact on underpricing. IPOs are underpriced on initial day to compensate for the risk inherent in it. While a list of risk proxies are suggested in literature, it actually invokes several complications in selecting the suitable risk for an IPO. Using the magnitude of underpricing as risk premium for initial investors, this paper seeks to shed light on the controversy by taking a sample of 171 IPOs issued in India during 2002-2007. Suitability of risk surrogates is examined to estimate underpricing. The findings revealed that high price deflated to low price (H/L) has a superior estimation power for underprice, suggesting H/L as a better indicator for uncertainty surrounding IPOs rather than other risk surrogates used in this study. Besides H/L, it is the investment bank prestige and inverse of offer proceeds which proved to be statistically significant in explaining underprice. Across sectors, H/L, investment bank prestige, and age of issue firm are found to be suitable risk proxies for IPOs from the manufacturing sector, while risk for the non-manufacturing sector IPOs is better explained by H/L, investment bank prestige, inverse of offer proceeds, and ex ante uncertainty