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Because traders reveal their information in a prediction market, the prediction market alone

provides evidence on IPO underpricing theories that rely on assumptions about the distribution of

information before an IPO. Our evidence suggests that traders were able to estimate accurately the post

IPO value of Google. Further, they revealed this information for very little payment. In addition, we

show that the correlation between ex ante forecasts of underpricing and the implied degree of uncertainty

in traders’ forecasts runs counter to models based on asymmetric information across traders. Because this

evidence does not depend on Google’s unique IPO auction mechanism in any way, we argue that this is

general evidence against three types of asymmetric information based theories: (1) theories that rely on

outsiders being relatively uninformed, (2) theories that rely on outsiders being relatively informed and

revealing that information only in exchange for large payments and (3) theories that rely on significant

winner’s curse problems.

Google’s IPO provides a particularly constructive setting for prediction markets because of its

unique features. Google’s specific and clearly stated goal was to avoid IPO underpricing. To achieve this

goal, they used an auction mechanism for gathering information, setting prices and allocating shares.

Thus, the IPO price provides a natural benchmark for evaluating the accuracy of prediction markets and

their potential usefulness in aggregating information in an IPO setting. But, more importantly, the

auction mechanism provides unique evidence on theory. First, evidence from the auction outcome allows

us to make inferences about Google’s pre-IPO information. The evidence suggests that Google also knew

the degree of underpricing that would result from the price they set. Combined with the prediction market

evidence, we think it makes a compelling case against asymmetric information based theories of IPO

underpricing in the specific case of Google. Second, Google’s auction mechanism gives two additional

pieces of evidence relevant to theory: (1) the auction severely restricted the investment bankers’

discretion in issuing shares and (2) the auction did not allow Google to pre-commit to underpricing.

Because of this design, the underpricing that occurred in Google’s case cannot be explained by models

that rely on either of these features.


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