Does sentiment drive the retail demand for IPOs?∗

Individual and institutional investors can trade German initial public equity offerings (IPOs) on a when-issued basis before the start of secondary trading. Using a novel data set of preand post-IPO trades made by a sample of clients at a large German retail broker, the paper documents that retail investors are willing to overpay and end up overpaying for IPOs, especially following periods of high returns in recent new issues. IPOs that are more aggressively bought by retail investors post higher first-day returns, but also experience lower aftermarket returns, controlling for market returns and firm characteristics such as size and book-to-market ratio. In short, sentiment – expectations about asset values unwarranted by fundamentals – drives retail purchases of IPOs and appears to have a transitory effect on prices. ∗Part of this paper was written during a dissertation internship in the International Finance Division of the Federal Reserve Board. I thank Fang Cai, Larry Glosten, Will Goetzmann, Charles Himmelberg, Gur Huberman, Wei Jiang, Anne Jones, Alexander Ljungqvist, Rob Martin, Pegaret Pichler, Paul Sengmueller, and Suresh Sundaresan for their comments and the Federal Reserve Board for its hospitality. †LeBow College of Business, Drexel University; 208 Academic Building; 101 North 33rd Street; Philadelphia, PA 19104; Email: [email protected]