Vector Auto-regressive Analysis of Determinants of IPO Underpricing: Empirical Evidence from Bombay Stock Exchange

Abstract

Underpricing of IPOs has been contemplated as a prevalent phenomenon across the world. The principal objective of the article is to investigate the difference in the firm and market specific factors that significantly affect the level of underpricing of IPOs. The sample for the study consists of 320 IPOs, listed at Bombay Stock Exchange (BSE). All the market and firm specific variables are regressed against the level of underpricing. Cross-sectional multiple regressions are used to reveal which variables are relevant in affecting the level of underpricing. A two-way ANOVA is done to see whether there is a statistically significant difference in the level of underpricing between book build issues and fixed price issues. Based on the multiple regression results, we found the values of R square and adjusted R square to be 43 per cent and 40 per cent, respectively. In this study vector autoregressive (VAR) analysis is also the reason that it can be helpful in the understanding of interrelationships among worldly variables and in the formulation of a more structured economic model. The study revealed that there is a negative relationship between issue sizes—firm’s age, firms issuing IPO for the first time, book built pricing mechanism, and the number of underwriters (dummy variable) with the level of underpricing. However, there is positive relationship between subscription rate, market capitalization, and number of shares offered at the level of underpricing. On the other hand, there is no consequential difference between a level of underpricing and timing of the offer. Consequently, the study provides useful insight into which market and firm specific variables are significant in determining the extent of underpricing of IPOs. The study has important implications for investors who subscribe to different IPOs for listing day gain as this study would help them in understanding which type of firms are more likely to be underpriced.