An experimental analysis of the IPO pricing mechanism: The case of Book-building

In this study, we conduct an experimental verification of the initial public offering (IPO) pricing method. Our focus lies on the inefficiencies in the Book-building (BB) method, particularly the deviation between the IPO price and the stock’s fundamental value.Based on the theoretical model by Biais and Faugeron-Crouzet (2002), our experiment reveals that the BB method frequently results of IPO overpricing relative to the fundamental value. This inefficiency in pricing is attributable to several factors, including insufficient compensation for information elicitation, lack of investor understanding, and positive investor sentiment as explained by the Active Participation Hypothesis.Our results also indicate that the presence of inexperienced investors is the main reason for overpricing, suggesting the importance of ensuring the participation of sophisticated institutional investors to ensure pricing accuracy. This feature also partly explains the price increase on the first trading day of aftermarket trading.