Valuation Uncertainty and Short-Sales Constraints: Evidence from the IPO Aftermarket

We use the initial public offering (IPO) setting to provide evidence that the combination of valuation uncertainty and short-sales constraints generates significant equity market mispricing. The IPOs that we predict to be most susceptible to overpricing in the immediate aftermarket have first-day returns of +47% and lockup expiration returns of $-$9%. Our detailed analysis of securities lending market data confirms that these IPOs experience severe short-sales constraints that peak around the lockup expiration. Our paper both explains the anomalous pricing of IPOs and highlights the importance of valuation uncertainty and short-sales constraints in explaining equity mispricing.

This paper was accepted by Brian Bushee, accounting.