Initial Public Offerings under Ambiguity

Yehuda Izhakian and Jaime Zender

Abstract

We use the new issues market as a laboratory in which to examine the impact of ambiguity on the pricing of financial assets. The process by which an underwriter establishes the offer price in an IPO is modeled assuming ambiguity regarding the returns on financial assets and that investors and the underwriter are risk and ambiguity averse. The model indicates that the underwriter will price both the systematic and the idiosyncratic component of the IPO firm's ambiguity in setting the offer price. Conversely, well diversified investors in the aftermarket require only a return premium for the systematic component of ambiguity. This difference in pricing between the offer and the aftermarket price suggests an impact of ambiguity on asset prices will be highlighted in IPO underpricing. Empirically, we find strong support for this (and other) prediction(s) of the model.