Hostname: page-component-77c89778f8-cnmwb Total loading time: 0 Render date: 2024-07-23T10:56:42.790Z Has data issue: false hasContentIssue false
  • English
  • Français

IPO First-Day Return and Ex Ante Equity Premium

Published online by Cambridge University Press:  18 February 2011

Hui Guo
Hui Guo*
Affiliation:
College of Business Administration, University of Cincinnati, PO Box 210195, Cincinnati, OH 45221. hui.guo@uc.edu
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper proposes a measure of ex ante equity premium, IPOFDR, which is the average difference between the initial public offering (IPO) offer price and the 1st-trading-day close price. I test the idea in 3 ways. First, there is a positive relation between IPOFDR and future market returns. Second, changes in IPOFDR help explain the cross section of stock returns. Third, the predictive power of IPOFDR for stock returns reflects mainly its close relation with market variance and average idiosyncratic variance—arguably measures of systematic risk. These results cast doubt on the notion that the IPO 1st-day return is a measure of investor sentiment.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 46 , Issue 3 , June 2011 , pp. 871 - 905
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2011

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Andersen, T. G.; Bollerslev, T.; Diebold, F. X.; and Labys, P.. “Modeling and Forecasting Realized Volatility.” Econometrica, 71 (2003), 579–625.Google Scholar
Baker, M., and Wurgler, J.. “The Equity Share in New Issues and Aggregate Stock Returns.” Journal of Finance, 55 (2000), 2219–2257.CrossRefGoogle Scholar
Baker, M., and Wurgler, J.. “Investor Sentiment and the Cross-Section of Stock Returns.” Journal of Finance, 61 (2006), 1645–1680.Google Scholar
Baker, M., and Wurgler, J.. “Investor Sentiment in the Stock Market.” Journal of Economic Perspectives, 21 (2007), 129–151.Google Scholar
Bansal, R., and Yaron, A.. “Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles.” Journal of Finance, 59 (2004), 1481–1509.CrossRefGoogle Scholar
Benveniste, L. M., and Spindt, P. A.. “How Investment Bankers Determine the Offer Price and Allocation of New Issues.” Journal of Financial Economics, 24 (1989), 343–361.Google Scholar
Bradley, D. J., and Jordan, B. D.. “Partial Adjustment to Public Information and IPO Underpricing.” Journal of Financial and Quantitative Analysis, 37 (2002), 595–616.Google Scholar
Campbell, J. Y. “Stock Returns and the Term Structure.” Journal of Financial Economics, 18 (1987), 373–399.Google Scholar
Campbell, J. Y. “Intertemporal Asset Pricing without Consumption Data.” American Economic Review, 83 (1993), 487–512.Google Scholar
Campbell, J. Y. “Viewpoint: Estimating the Equity Premium.” Canadian Journal of Economics, 41 (2008), 1–21.Google Scholar
Campbell, J. Y., and Cochrane, J. H.. “By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior.” Journal of Political Economy, 107 (1999), 205–251.Google Scholar
Campbell, J. Y., and Shiller, R. J.. “The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors.” Review of Financial Studies, 1 (1988), 195–228.Google Scholar
Campbell, J. Y., and Vuolteenaho, T.. “Bad Beta, Good Beta.” American Economic Review, 94 (2004), 1249–1275.Google Scholar
Cao, C.; Simin, T.; and Zhao, J.. “Can Growth Options Explain the Trend in Idiosyncratic Risk?” Review of Financial Studies, 21 (2008), 2599–2633.Google Scholar
Carlson, M.; Fisher, A.; and Giammarino, R.. “Corporate Investment and Asset Price Dynamics: Implications for SEO Event Studies and Long-Run Performance.” Journal of Finance, 61 (2006), 1009–1034.CrossRefGoogle Scholar
Clark, T. E., and McCracken, M. W.. “Tests of Equal Forecast Accuracy and Encompassing for Nested Models.” Journal of Econometrics, 105 (2001), 85–110.CrossRefGoogle Scholar
Cochrane, J. H. “The Dog That Did Not Bark: A Defense of Return Predictability.” Review of Financial Studies, 21 (2008), 1533–1575.Google Scholar
Cornell, B.. “Risk, Duration, and Capital Budgeting: New Evidence on Some Old Questions.” Journal of Business, 72 (1999), 183–200.Google Scholar
Dechow, P. M.; Sloan, R. G.; and Soliman, M. T.. “Implied Equity Duration: A New Measure of Equity Risk.” Review of Accounting Studies, 9 (2004), 197–228.Google Scholar
Edelen, R. M., and Kadlec, G. B.. “Issuer Surplus and the Partial Adjustment of IPO Prices to Public Information.” Journal of Financial Economics, 77 (2005), 347–373.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Dividend Yields and Expected Stock Returns.” Journal of Financial Economics, 22 (1988), 3–25.Google Scholar
Fama, E. F., and French, K. R.. “Business Conditions and Expected Returns on Stocks and Bonds.” Journal of Financial Economics, 25 (1989), 23–49.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Multifactor Explanations of Asset Pricing Anomalies.” Journal of Finance, 51 (1996), 55–84.Google Scholar
Fama, E. F., and MacBeth, J. D.. “Risk, Return, and Equilibrium: Empirical Tests.” Journal of Political Economy, 81 (1973), 607–636.Google Scholar
French, K. R.; Schwert, G. W.; and Stambaugh, R. F.. “Expected Stock Returns and Volatility.” Journal of Financial Economics, 19 (1987), 3–29.Google Scholar
Glosten, L. R.; Jagannathan, R.; and Runkle, D. E.. “On the Relation between the Expected Value and the Volatility of the Nominal Excess Return on Stocks.” Journal of Finance, 48 (1993), 1779–1801.Google Scholar
Guo, H., and Savickas, R.. “Average Idiosyncratic Variance in G7 Countries.” Review of Financial Studies, 21 (2008), 1259–1296.Google Scholar
Guo, H., and Whitelaw, R.. “Uncovering the Risk-Return Relation in the Stock Market.” Journal of Finance, 61 (2006), 1433–1463.Google Scholar
Hahn, J., and Lee, H.. “Yield Spreads as Alternative Risk Factors for Size and Book-to-Market.” Journal of Financial and Quantitative Analysis, 41 (2006), 245–269.CrossRefGoogle Scholar
Hanley, K. W. “The Underpricing of Initial Public Offerings and the Partial Adjustment Phenomenon.” Journal of Financial Economics, 34 (1993), 231–250.CrossRefGoogle Scholar
Ibbotson, R. G. “Price Performance of Common Stock New Issues.” Journal of Financial Economics, 2 (1975), 235–272.Google Scholar
Lettau, M., and Ludvigson, S.. “Consumption, Aggregate Wealth, and Expected Stock Returns.” Journal of Finance, 56 (2001), 815–849.Google Scholar
Lettau, M., and Ludvigson, S. C.. “Expected Returns and Expected Dividend Growth.” Journal of Financial Economics, 76 (2005), 583–626.CrossRefGoogle Scholar
Lettau, M., and Wachter, J. A.. “Why Is Long-Horizon Equity Less Risky? A Duration-Based Explanation of the Value Premium.” Journal of Finance, 62 (2007), 55–92.CrossRefGoogle Scholar
Li, E. X. N.; Livdan, D.; and Zhang, L.. “Anomalies.” Review of Financial Studies, 22 (2009), 4301–4334.Google Scholar
Ljungqvist, A.. “IPO Underpricing.” Working Paper, New York University (2004).Google Scholar
Ljungqvist, A.; Nanda, V.; and Singh, R.. “Hot Markets, Investor Sentiment, and IPO Pricing.” Journal of Business, 79 (2006), 1667–1702.Google Scholar
Logue, D.. “Premia on Unseasoned Equity Issues, 1965–69.” Journal of Economics and Business, 25 (1973), 133–141.Google Scholar
Loughran, T., and Ritter, J. R.. “Why Don’t Issuers Get Upset About Leaving Money on the Table in IPOs?” Review of Financial Studies, 15 (2002), 413–443.Google Scholar
Lowry, M.. “Why Does IPO Volume Fluctuate So Much?” Journal of Financial Economics, 67 (2003), 3–40.CrossRefGoogle Scholar
Lowry, M., and Schwert, G. W.. “Is the IPO Pricing Process Efficient?” Journal of Financial Economics, 71 (2004), 3–26.Google Scholar
Lowry, M., and Shu, S.. “Litigation Risk and IPO Underpricing.” Journal of Financial Economics, 65 (2002), 309–335.Google Scholar
Lyandres, E.; Sun, L.; and Zhang, L.. “The New Issues Puzzle: Testing the Investment-Based Explanation.” Review of Financial Studies, 21 (2008), 2825–2855.CrossRefGoogle Scholar
McCracken, M. W. “Asymptotics for Out of Sample Tests of Granger Causality.” Journal of Econometrics, 140 (2007), 719–752.CrossRefGoogle Scholar
Merton, R. C. “An Intertemporal Capital Asset Pricing Model.” Econometrica, 41 (1973), 867–887.Google Scholar
Merton, R. C. “On Estimating the Expected Return on the Market: An Exploratory Investigation.” Journal of Financial Economics, 8 (1980), 323–361.Google Scholar
Pastor, L.; Sinha, M.; and Swaminathan, B.. “Estimating the Intertemporal Risk-Return Tradeoff Using the Implied Cost of Capital.” Journal of Finance, 63 (2008), 2859–2897.Google Scholar
Pastor, L., and Stambaugh, R. F.. “Predictive Systems: Living with Imperfect Predictors.” Journal of Finance, 64 (2009), 1583–1628.CrossRefGoogle Scholar
Pastor, L., and Veronesi, P.. “Stock Valuation and Learning about Profitability.” Journal of Finance, 58 (2003), 1749–1790.Google Scholar
Pastor, L., and Veronesi, P.. “Rational IPO Waves.” Journal of Finance, 60 (2005), 1713–1757.Google Scholar
Petkova, R.. “Do the Fama-French Factors Proxy for Innovations in Predictive Variables?” Journal of Finance, 61 (2006), 581–612.Google Scholar
Ritter, J. R. “The Long-Run Performance of Initial Public Offerings.” Journal of Finance, 46 (1991), 3–27.Google Scholar
Ritter, J. R. “Investment Banking and Securities Issuance.” In Handbook of the Economics of Finance, vol. 1B, Constantinides, G. M., Harris, M., and Stulz, R. M., eds. Amsterdam, The Netherlands: North-Holland (2003).Google Scholar
Ritter, J. R., and Welch, I.. “A Review of IPO Activity, Pricing, and Allocations.” Journal of Finance, 57 (2002), 1795–1828.Google Scholar
Rock, K.. “Why New Issues Are Underpriced.” Journal of Financial Economics, 15 (1986), 187–212.CrossRefGoogle Scholar
Scruggs, J. T. “Resolving the Puzzling Intertemporal Relation between the Market Risk Premium and Conditional Market Variance: A Two Factor Approach.” Journal of Finance, 53 (1998), 575–603.Google Scholar
Scruggs, J. T., and Glabadanidis, P.. “Risk Premia and the Dynamic Covariance between Stock and Bond Returns.” Journal of Financial and Quantitative Analysis, 38 (2003), 295–316.Google Scholar
Shanken, J.. “On the Estimation of Beta-Pricing Models.” Review of Financial Studies, 5 (1992), 1–33.Google Scholar
Tiniç, S. M. “Anatomy of Initial Public Offerings of Common Stock.” Journal of Finance, 43 (1988), 789–822.Google Scholar
Welch, I.. “Sequential Sales, Learning, and Cascades.” Journal of Finance, 47 (1992), 695–732.Google Scholar
Welch, I., and Goyal, A.. “A Comprehensive Look at the Empirical Performance of Equity Premium Prediction.” Review of Financial Studies, 21 (2008), 1455–1508.Google Scholar
Whitelaw, R. F. “Time Variations and Covariations in the Expectation and Volatility of Stock Market Returns.” Journal of Finance, 49 (1994), 515–541.Google Scholar