Testing for Deliberate Underpricing in the IPO Premarket : A Stochastic Frontier Approach

We re-evaluate the IPO underpricing phenomenon using the stochastic frontier methodology. The advantage of the stochastic frontier is that it can be used to measure the level of deliberate underpricing in the premarket without using aftermarket information. This is accomplished through the estimation of a systematic one-sided error term that measures quot;inefficiencyquot; or the difference between the maximum predicted offer price and the actual offer price. Data for the analysis are comprised of 1035 initial public offers of common stock issued by firm commitment between 1975-1984. IPOs appear to be deliberately underpriced in the premarket in both hot market and non-hot market periods. Moreover, the determinants of the maximum IPO price have different effects in the two time periods