Positive feedback traders, the offer price constraint and IPO pricing

Traditional IPO (initial public offering) underpricing theory is doubt by some empirical findings of IPO overpricing, and cannot explain well why there is the offer price-earning ratio constraint for a long time in China. This paper insists that there are many positive feedback traders in the primary market, whose demands of the new stock mainly depend on recent IPO initial returns. The existing of the positive feedback traders makes the IPO a success even if the offer price is overpriced. The issuer and the underwriter realize it, and then they will improve the offer price to maximize their benefit. Institutional investors usually overvalue the new stock when the recent IPO initial returns are high, so they can accept the higher offer price. The empirical results prove the positive effect of positive feedback traders in the primary market on offer price, and indicate that the offer PE ratio constraint can restrain the positive effect.