Speculative Initial Public Offerings A Disagreement Approach to the IPO Puzzle

Abstract

We model the effect of disagreement on short-term IPO underpricing and long-term IPO underperformance. Given the existence of short-sales constraints and momentum traders, sufficiently high disagreement amongst investors triggers short-term overperformance and long-term underperformance as momentum traders magnify the effect of short-term disagreement. We verify these predictions empirically using data for aggregate disagreement and various measures of IPO abnormal returns, turnover, and frequency. We find that aggregate disagreement has an increasingly positive effect on initial post-IPO abnormal returns and turnover, and a negative effect on long-term post-IPO abnormal returns. Our results also indicate that the effect of aggregate disagreement is being amplified by gradual information diffusion in both the short- and long-term. This paper therefore provides a new model combining the disagreement and information cascades hypotheses of the IPO Puzzle, and new empirical evidence explaining the IPO Puzzle through aggregate disagreement.