Beyond fundamentals

: how investor sentiment shapes the IPO underpricing puzzle in Japan

Abstract

The underpricing of Initial Public Offerings remains one of the most complex puzzles in finance, despite decades of research. While classical theories offer partial explanations, this thesis focuses on an alternative perspective: the irrational behavioural aspects of investors. Specifically, it examines the persistent phenomenon of IPO underpricing in Japan, a market known for its exceptionally high levels of underpricing, and its relationship with investor sentiment. In addition, the study explores the dynamics between underwriter choice and underpricing, as the bookbuilding pricing mechanism implemented in Japan grants underwriters significant control over the offering process. To achieve this, I develop an investor sentiment index composed of four market-level proxies and two firm-level proxies. Using ordinary least squares (OLS) regression models applied to a sample of 2,234 Japanese IPOs from January 1999 to December 2023, the analysis reveals a positive and statistically significant relationship between underpricing and the investor sentiment index. Robustness checks further reinforce the conclusion that investors driven by false expectations and irrational decision-making contribute to the substantial “money left on the table.” The findings regarding underwriter prestige are nuanced. While the main models suggest that prestigious underwriters might amplify underpricing, alternative specifications imply that they can also reduce information asymmetry and help mitigate underpricing. This study contributes to an understanding of IPO pricing dynamics in Japan, offering valuable insights for investors, issuers, underwriters, and regulators seeking to improve capital market efficiency.

Date of Award	5 May 2025
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	Eva Schliephake (Supervisor)