How does retail sentiment affect IPO returns? Evidence from the internet bubble period

Using small-sized buyer-initiated trades as the proxy for retail demand, we study how retail sentiment affects the returns of IPOs completed on the U.S. markets between 1994 and 2004. While we find that retail sentiment is positively related with the return volatility of IPOs on the first trading day within the whole sample period, such positive sentiment-volatility relation is the strongest during the 1999-2000 internet bubble period. Furthermore, overoptimism among sentiment investors during the bubble period results in a negative relation between retail demand and long-run post-IPO price performance. This negative relation is robust, economically significant, and can be found when the long-run post-IPO abnormal returns are adjusted by style or adjusted by industry. Overall, there is evidence that the behavior of bullish retail investors can lead to overpricing of U.S. IPO shares and price reversals in the long run.