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Prevalence of The Winner’s Curse in Initial Public Offerings

When a company first goes public, investors must decide whether or not they want to buy shares at the listed initial price. Since investors intend to resell shares after a holding period, it is important for them to know how other investors value them and how much they can eventually resell them for. Different investors with varying amounts of information about a company will arrive at different future values for a share of its stock.

Immediately after shares of a company begin trading publicly, investors who believe that the true value of a share is higher than its current price will buy some. Increasingly optimistic investors – who believe that the share’s true value exceeds the market’s price – will continue buying shares, which continues to increase its price. Eventually, the share reaches a certain price, specifically, the price that the most optimistic bidder is willing to pay, and stops climbing higher. This typically happens within the first few days of trading.

This scenario can be viewed as a type of auction in which bidders intend to resell the item and do not know its common value. If we take the average of every investor’s value to be an estimate of the common value, then the individual values are distributed around it in some way. The investors who “won” the auction, meaning they got the share of stock in the end, are the ones whose estimates were above the common value as we defined it. If the share price eventually settles back down to the common value or below, then the “winning” investor will lose money, demonstrating a prime example of the winner’s curse.

One recent example is the Snap Inc IPO that took place earlier this year. Shares were offered for around $17 each initially, but within a day of trading, the most optimistic investors had pushed the price up to $25. They won the auction by being able to obtain shares of the company, but in fact, they lost significantly when shares dropped steeply in price to around $15, where it remains today.

 

Sources:

http://fortune.com/2017/03/21/snapchat-snap-ipo-wall-street/

http://fortune.com/2017/03/02/snapchat-ipo-snap-disaster/

http://www.ipo-underpricing.com/UP/Underpricing/Modelle/GG/e_Winners%20Curse.html

https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp428.pdf?c2ec5097d1527918d87c2c5b45ebe24b

https://www.dailyreckoning.co.uk/penny-shares/tech-investors-and-the-winners-curse/

http://www.etf.com/sections/index-investor-corner/swedroe-ipos-overhyped-investment-idea?nopaging=1

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