The Effect of Differences of Opinion and Market Conditions on the Pricing of IPOs by Investment Banks

44 Pages Posted: 23 Mar 2009 Last revised: 31 Jul 2012

Date Written: November 29, 2010


I model the pricing decision of an investment bank that manages a book-built IPO and faces a stochastic downward sloping demand curve for the firm’s IPO shares. The model distinguishes between the effect of differences of opinion and valuation uncertainty on the pricing decision of the investment bank and hence average IPO initial returns. Without relying upon information asymmetries between agents, the model predicts several empirical regularities: average positive initial returns, the ubiquitous use of the over-allotment option, partial adjustment of offer prices to observable information, and extreme initial returns in a bubble. The model provides insight into the how investment banks interpret and price information. For example, news stories about the IPO firm attract potential new investors, many of which are plausibly sentiment investors. My model shows two effects of news stories on the stochastic demand curve. First, the new investors cause an outward shift out in the demand curve. Second, the new investors, many of whom are sentiment investors, increase valuation uncertainty. The investment bank raises the offer price due to the shift in demand caused by news stories, but only partially because of the increase in valuation uncertainty.

Keywords: Initial Public Offering, Investment Bank, Underwriter, Offer Price, First Day Returns,Effort, Bubble, Bargaining Power

JEL Classification: D40, D81, G24

Suggested Citation

O'Connor Keefe, Michael, The Effect of Differences of Opinion and Market Conditions on the Pricing of IPOs by Investment Banks (November 29, 2010). Available at SSRN: or

Michael O'Connor Keefe (Contact Author)

Victoria University of Wellington ( email )

P.O. Box 600
Wellington, 6140
New Zealand

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