Is Chinese IPO initial return underpricing or overvaluation? A new evidence based on stochastic frontier models

Abstract

It has been controversial for the formation mechanism of IPO initial returns anomaly. The underpricing explanation based on asymmetric information is well accepted, but could not explains that in emerging markets; the overvaluation explanation based on behavioral finance has more applicability in emerging markets, but cannot be supported well by empirical test because of the difficult of explanatory variables. This paper analyzes the four main possibility of the formation mechanism of IPO initial returns, and chooses the issue PE ratio as the proxy to do empirical test of the IPO pricing efficiency with a sample of Chinese IPOs during 1998-2007, based on the stochastic frontier models, as to provide the new evidence of the overvaluation explanation of Chinese IPO initial returns indirectly.