Reference price formation under reverse market conditions: Evidence from IPO trading volume

Abstract

This thesis studies the reference price formation under reverse market conditions, determined by the prevailing bull and bear sentiment trends. I investigate the turnover changes after initial public offering (IPO), which forms a natural reference point for the investors, to which they compare all forthcoming price movements.

The results imply that a stock is traded more when its market price exceeds the offer price, that the investor has initially paid to obtain the asset. Additionally, the IPO stocks that begin trading at a gain, tend to be traded more, as they fall below their initial purchase price for the first time. However, the initially losing stocks are not found to be traded more when their market price surpasses the initial offer price, which is not consistent with previous research.

Regarding the effect of the market trends, investors seem to be more optimistic in the formation of their reference prices during bull markets, than during bear conditions. Moreover, new stock price maximums and minimums seem to strongly influence the reference point formation across different market conditions. Under bull circumstances, investors are also more quicker in reacting to new price maximums and minimums, when compared to the bear conditions, under which the reference prices do not seem to be updated as strongly, if at all, to new price crossings. Therefore, it can be interpreted that investors do adapt their notions on winnings and losses based on new information gained from the stock's current market performance, as they tend to wait longer to sell a losing stock and are also more eager to sell the winning stock before it rises any further. Finally, investors seeming to react faster during bull trends can be due to more frequent follow-up of their assets, which has been found characteristic for bull market investors.