Abstract: There are three behavioral phenomena associated with initial public offerings (IPOs). These have been termed (1) initial underpricing; (2) long-term underperformance; and (3) “hot issue” market. Initial underpricing occurs when the offer price is too low. In this case, the issue will be underpriced and its price will soar on the first trading day. But price may overshoot fundamental value. In this case, it will fall back over time, giving rise to long-term underperformance. IPO activity also appears to move in cycles, hot and cold. A “hot issue” market is a period when investor demand for IPOs is especially high. Are the three IPO phenomena consistent with market efficiency? They are not. In a “hot issue” market, excessive optimism on the part of investors leads IPO prices to rise above fundamental value on the first trading day, and remain so for long periods. This optimism is a manifestation of heuristic-driven bias. Investors may also be affected by other heuristics. The chapter discusses instances of similarity, betting on trends, representativeness, and regret. Two cases are used to illustrate IPO phenomena, Boston Chicken and Netscape.

Keywords: betting on trends, hot issue markets, initial underpricing, long-term underperformance, optimism, regret, representativeness, similarity,