II-4\ The use of Grey Market Data:
Cornelli, Goldreich and Ljungqvist (2004) try
to take advantage of the existence of a grey market in Europe to construct a
model on European Initial Public Offerings to look at whether the presence of
sentiment investors affects prices in the post-IPO market and whether
investors' sentiment can explain and be considered as a driver and primary
determinant of underpricing anomaly.
Before going in details and presenting the findings of these
authors, I should begin by defining the grey market and presenting some
assumptions in their model to understand their results.
The Grey Market is a when-issued market for shares to be
issued in an IPO (the definition as given by the authors).
Most European countries have grey markets for IPOs. It is a
Pre-IPO market taking place at the same time as institutional bookbuilding
(before setting the issue price definitively). In this market, retail and
smaller investors speculate on the post-IPO share price, so these investors are
trading IPOs before they are listed on the stock market. The prices at which
they speculate are considered as post-IPO share prices and that is why the grey
market is considered as an opportunity to observe the post-IPO prices and the
opinion of small investors and to foresee their behaviour in the after market.
The grey market is an opportunity to foresee what it will be in the IPO
after-market. It is the unique opportunity to observe the valuation of the
investors who will be buying shares in the aftermarket and to measure the
expectations of sentiment investors directly. It is also beneficial to the
issuers to increase the offer price and then the IPO proceeds. In the U.S,
regulations prohibit the existence of Grey Markets and the speculation of IPO
shares before they are listed on the stock market.
The assumptions used by the authors in this article are the
following:
The grey market investors may overweight the relevance of
their information, so the authors allow for the possibility that grey market
investors are sentiment investors but they do not impose it.
When the publicly observable grey market price is high
relative to fundamental value, bookbuilding investors resell shares to these
smaller investors in the aftermarket, so the offer price and the aftermarket
price will be close to the grey market price. In contrast, when the grey market
price is low, the offer and aftermarket prices will be close to fundamental
value. Because the fundamental value is unobservable, econometricians usually
take the midpoint of the initial indicative price range as a proxy for
fundamental value.
The dataset consists of 486 companies which went public in
twelve European countries between November 1995 and December 2002 and for which
there exist grey market prices. To give a valuation to the investor sentiment,
the authors use the normalized last grey market price before the issue price
was set: PGM / P mid (the midpoint of
the initial indicative price range). They find that there is a positive
correlation between grey market price, issue price and aftermarket price. The
grey market price is more correlated with the issue and the aftermarket prices
when the grey market price is high, although there is a positive correlation
even when the grey market price is low. So this positive correlation confirms
the fact that the presence of sentiment investors has an impact on after market
prices and so on the underpricing anomaly.
In conclusion, Cornelli, Goldreich and Ljungqvist (2004) find
that high pre-IPO prices, which indicate overly optimistic investors, are a
good predictor of high initial returns during the first trading day. And then,
the high investor sentiment valued by high grey market prices, is a primary
driver and determinant of the short run IPO anomaly.
When small investors are excessively optimistic, they are
willing to pay a price above the fundamental value, resulting in a high
aftermarket price (foreseen through the grey market prices), and so in
underpricing. But when these sentiment investors are pessimistic about an
issue, their opinion has less of an effect on the aftermarket and issue prices
that will be close to the fundamental value and not to the grey market, which
suggests that the underwriter and sophisticated investors can identify
sentiment investors. Thus, they consider the opinion of sentiment investors
biased, and they take it into account only when they can profit from it, by
selling shares to them in the aftermarket.
Cornelli, Goldreich and Ljungqvist (2004), are not the first
authors using the grey market in their study to value the investor sentiment
trying to explain the short run IPO anomaly. There are other earlier studies
that are complementary to the findings of these authors. For example, Dorn
(2003) finds that the volume of grey market trading among the customers of a
German retail brokerage is correlated with high initial returns and low
long-run returns. This can be viewed as further evidence that participation by
smaller investors in the grey market can be interpreted as sentiment. Besides
Dorn (2003), two other papers study the grey market in Germany: Loffler,
Panther and Theissen (2002) document that grey market prices are unbiased
estimates of first-day prices. Aussenegg, Pichler, and Stomper (2003) also find
that IPO offer prices are related to prices in the grey market but they show
that the coefficient is smaller than one. Finally, Pichler and Stomper (2004)
model the interaction between bookbuilding and the grey market when grey market
investors have similar information to bookbuilding investors. They ask whether
the existence of a grey market helps or hinders information aggregation in
bookbuilding. In contrast, Cornelli, Goldreich and Ljungqvist (2004), introduce
a class of investors who have different information from bookbuilding
investors, in order to explain certain IPO phenomena and to show how these
(possibly biased) investors affect prices.
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