II-5\ The use of market conditions to value investor's
sentiment:
François Derrien (2003) explores the
impact of investor sentiment on the pricing and aftermarket behaviour of IPOs,
using a sample of 62 initial public offerings realized on the French stock
exchange between 1999 and 2001. He tests a model in which the first day closing
price of IPOs and then initial returns and underpricing are depending on the
information about the intrinsic value of the company (revealed by institutional
investors and it is private information) and on investor sentiment. These
French offerings used a unique IPO mechanism: a modified book-building
procedure in which a fraction of the IPO shares is reserved for individual
investors. This mechanism was created in 1999 and is unique to the French stock
exchange: the Offre à Prix Ouvert (OPO).
To value the investors' sentiment, Derrien focus on these
individual investors' demand which is related to the market conditions. These
individual investors are typically small and uninformed, that is why they are
considered as sentiment investors and their demand is a direct measure of
sentiment.
The demand for IPO shares submitted by individual investors
varies considerably and is strongly and positively related to a measure of
market conditions prevailing at the time of the offering. When these conditions
are favourable, the investor sentiment is high and individual investors seem to
be overly optimistic, presenting a large demand for IPO shares. This demand
surely influences IPO prices and then the underpricing phenomenon to a large
extent. It leads to high IPO after market prices and then to large initial
returns: the more favourable market conditions, the larger the individual
investors' demand, the higher the investor sentiment and the higher after
market prices, keeping everything else constant.
Loughran and Ritter (2002) and others have provided indirect
empirical evidence of this short run IPO phenomenon using various measures of
market conditions as proxies for investor sentiment. For example, to measure
the market conditions, the return of the industry index the IPO company belongs
to in the recent period preceding the offering can be used. Loughran and
Ritter use the three week period. But in this paper, the author uses a direct
measure of the investor sentiment, namely the demand for IPO shares posted by
individual investors in the French IPOs used in data, these investors are
considered as sentiment investors and so their demand is a direct measure of
sentiment.
Derrien and Womack (2003) show that the initial returns on
IPOs in France in the 1992-1998 period were predictable using the market
returns in the three-month period preceding the offerings. Using U.S. data,
Loughran and Ritter (2002) and Lowry and Schwert (2003) obtain similar results:
in that the initial returns in the first day of trading for IPOs are
predictable using the market conditions prevailing at the time of the IPOs or
at a recent past.
Bradley and Jordan (2002) include the 1999 `hot issue' market
in their sample and find that more than 35% of initial returns can be predicted
using public information available at IPO date. However, Lowry and Schwert
(2003) find that the effect is economically small, the relation between
underpricing and market conditions (market returns) is statistically but not
economically significant.
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