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The Efficient IPO Market Hypothesis: Theory and Evidence

Published online by Cambridge University Press:  23 January 2020

Kevin R. James Open the ORCID record for Kevin R. James [Opens in a new window]  and
Marcela Valenzuela
Kevin R. James*
Affiliation:
James, k.james1@lse.ac.uk, Systemic Risk Centre (SRC), London School of Economics (LSE)
Marcela Valenzuela
Affiliation:
Valenzuela, mavalenb@uc.cl, Universidad de Chile (DII) and Pontificia Universidad Católica de Chile
*
James (corresponding author), k.james1@lse.ac.uk
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Abstract

We derive the optimal underwriting method and the quantitative initial public offering (IPO) pricing rule that this method implies in a market with informational frictions consisting of fully rational banks, issuers, and investors. In an efficient IPO market, an issuer’s expected initial return will be determined entirely by the combination of this pricing rule and issuer fundamentals. Applying this rule, we find that we can explain the quantitative magnitude of the principal aspects of the time-series and cross-sectional variation in IPO average initial returns. We conclude that the IPO market is efficient.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 55 , Issue 7 , November 2020 , pp. 2304 - 2333
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2020

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Footnotes

We thank Cindy Alexander, Jon Danielsson, Giulia Fantini, Charles Goodhart, Robert Macrae, David Reiffen, Claudia Robles-Garcia, Peter Sinclair, Redis Zaliauskas, and seminar participants at the LSE, U.S. Securities and Exchange Commission (SEC), and the University of Swansea for helpful comments and discussions. We thank Evgeny Lyandres (the referee) and Jarrad Harford (the editor) for suggestions that enabled us to improve our analysis and exposition substantially. We thank Katerina Karamani for research assistance. The support of the Economic and Social Research Council (ESRC) in funding the SRC is gratefully acknowledged (Grant No. ES/R009724/1). Valenzuela acknowledges the support of Fondecyt Project No. 1190477 and Instituto Milenio ICM IS130002. The views in this article are solely the responsibility of the authors.

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