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Underpricing implications on efficient market hypothesis

Most initial public offerings (IPO) are made with the assistance of an investment banker. The main activity of an investment banker is underwriting the issue. This process involves purchasing the security issue from the issuing corporation at an agreed upon price and bearing the risk of reselling it to the public at a profit. In an efficient market the price reflects the collective actions that the buyers and sellers take based on all available information.There is not a market until buyers start to buy the stock on the secondary market. Buyers and sellers digest the new information as it becomes available and move the stock price to an equilibrium.

Question:

If the IPO price is set by an investment banker and not market driven, what implications does underpricing have on the efficient market hypothesis?

Please include any reference.

Solution Preview

If IPO price is set by an investment banker and not market driven and is underpriced, the price is considered to be driven by company and not market forces. It is inefficient in the sense that investors will be able to beat the market and make listing gains due to the difference between the issue price set by the investment banker and the final listing price on the ...

Solution Summary

The solution discusses what implications does underpricing have on the efficient market hypothesis.

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