Abstract
This short article demonstrates an application of price auction theory to a securities underwriting market, which is characterized by the competitive behaviours of investment houses. An investigation of newly issued Japanese straight bonds, reported in a letter by Matsui (Citation2006), provided statistical evidence that issue yields tend to be set significantly lower than equilibrium yields. Consistent with that finding, the model presented in this letter demonstrates theoretically that increased underwriting competition reduces issue yields and that the degree of overpricing is positively correlated with the credit quality of the issuer.
Acknowledgements
The author gratefully acknowledges financial support from a Grant-in-Aid for Young Scientists (B) from the Japan Society for the Promotion of Science. The author is solely responsible for any remaining errors.
Notes
1Saunders et al. (Citation2002) proved that the microstructure of the corporate bond market in the United States closely resembles a first-price (English) sealed bid auction.
2Datta et al. (Citation1997) documented that the primary debt market in the US is also characterized by underwriting competition.
3For basic structures of various types of auctions, see Milgrom and Weber (Citation1982) and McAfee and McMillan (Citation1987).
4Moreover, Carter and Manaster (Citation1990) proved that underwriter reputation plays a role in reducing the degree of information asymmetry in equity markets. Matsuo (Citation1999) argued that the experience of the investment house underwriting a bond issued by a particular company significantly increases the future possibility of it underwriting other securities of the same company, which leads to more profits for the underwriter. He also pointed out that bond issuers in the United States tend to choose repeatedly a particular investment house as the lead managing underwriter because the issuer attempts to avoid the disclosure of its financial information.