Individual Investor Sentiment and IPO Stock Returns: Evidence from the Korean Stock Market

• Author: Joohwan Kim,Chune Young Chung,Jinwoo Park
• Date: 01 December 2017
• Published date: 01 December 2017
• DOI: http://doi.org/10.1111/ajfs.12199

Individual Investor Sentiment and IPO Stock

Returns: Evidence from the Korean Stock

Market*

Chune Young Chung

School of Business Administration, Chung-Ang University, Republic of Korea

Joohwan Kim

College of Business Administration, Hankuk University of Foreign Studies, Republic of Korea

Jinwoo Park**

College of Business Administration, Hankuk University of Foreign Studies, Republic of Korea

Received 9 October 2016; Accepted 9 May 2017

Abstract

This paper examines the impact of individual investors’ premarket and aftermarket sentiment

on initial public offering (IPO) stock returns, based on 382 IPO firms in the Korean stock

market from 2007 to 2014. The results reveal that individual investors’ premarket sentiment

is significantly and positively related to the initial returns, as measured by the difference

between the offer price and the first-day opening price. The findings also show that individ-

ual investors’ premarket sentiment is positively associated with their aftermarket sentiment,

implying a spillover effect from premarket to aftermarket sentiment. However, after high ini-

tial returns in IPO firms with individual investors’ high premarket sentiment, we find subse-

quent underperformance; this is more pronounced in firms with high premarket and

aftermarket sentiment. Overall, our results imply that individual investors’ premarket senti-

ment can largely explain IPO stock returns. Additionally, premarket sentiment followed by

aftermarket sentiment can account for IPO stocks’ underperformance. Nevertheless, the

impact of individual investor sentiment on IPO stock returns seems to be a short-term phe-

nomenon, as high initial returns and subsequent underperformance are more evident within

the first month after the IPO.

Keywords Individual investor; Premarket sentiment; Aftermarket sentiment; IPO stock

returns; Korean Stock Market

JEL Classification: G14, G15, G30

*The authors thank Professor Kwangwoo Park, the editor, and two anonymous reviewers for

their valuable comments. This work was supported by Hankuk University of Foreign Studies

Research Fund.

**Corresponding author: Jinwoo Park, College of Business Administration, Hankuk Univer-

sity of Foreign Studies, 107 Imun-ro, Dongdaemun-gu, Seoul, 02450, Korea. Tel: +82-2-

2173-3175, Fax: +82-2-959-4645, email: jwp@hufs.ac.kr.

Asia-Pacific Journal of Financial Studies (2017) 46, 876–902 doi:10.1111/ajfs.12199

876 ©2017 Korean Securities Association

1. Introduction

A substantial body of literature documents high initial returns on IPO stocks.

Studies have attempted to explain IPOs’ initial returns based on the asymmetric

information and reputation hypotheses. The former hypothesis is based on the

asymmetry of information between the issuer and the investors, and posits that

the IPO firm’s true value is known by the issuer, but not by the investors; thus,

investors require a lower offering price to compensate for information uncer-

tainty risk, and the issuer must set a lower offering price to attract these unin-

formed investors (Beatty and Ritter, 1986). Additionally, the reputation

hypothesis argues that a conflict of interest exists between the underwriter and

issuer, and, thus, underwriters have an incentive to set a lower offering price in

order to reduce the risk of IPO failure and to satisfy their clients (Beatty and

Welch, 1996).

In contrast, some studies argue that IPO stocks’ high initial returns can be

explained by overvaluation in the secondary market, or by the particularly high

stock price immediately after the IPO. The overvaluation story in particular is

largely related to investor sentiment.

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For example, Miller (1977) proposes that

short-sale constrained IPO stock prices could reflect only optimistic investors’

expectations, and, thus, lead to overpriced IPO stocks. Ritter and Welch (2002) and

Ljungqvist et al. (2006) show that the information asymmetry hypothesis cannot

fully explain IPOs’ high initial returns, and investor sentiment may be related to

this phenomenon. Purnanandam and Swaminathan (2004), Derrien (2005), and

Dorn (2009) also suggest that high initial returns could be the result of irrational

investor sentiment.

Related studies also suggest that overvalued IPO stock prices would revert to

their fundamental values eventually, and this could lead to long-term IPO under-

performance. For example, Aggarwal and Rivoli (1990), Ritter (1991), and Ritter

and Welch (2002) argue that fads stemming from investors’ irrational behavior

could drive excess demand for, and high initial returns on, IPO stocks, and this

implies long-term IPO underperformance as the excess demand clears over time.

However, these studies are limited as they fail to indicate a direct association

between investors’ fads and long-term IPO underperformance.

Recent studies have employed proxy variables for individual investor sentiment,

and have linked them to high initial returns on IPO stocks in order to investigate

an association between IPO stock returns and investors’ irrational behaviors more

directly. Derrien (2005) finds that book-building demand by individual investors in

the French market results in significant IPO stock price increases on the first trad-

ing day, and is subsequently negatively related to long-term IPO performance. Cor-

nelli et al. (2006) also find that high grey market prices lead to high first-day

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Baker and Wurgler (2007) suggest that investor sentiment and speculative behavior are more

pronounced for the stock prices of firms with high information uncertainty.

Individual Investor Sentiment and IPO

©2017 Korean Securities Association 877