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Liquidity Risk, Leverage and Long-Run IPO Returns

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Author Info
Eckbo, B Espen
Norli, Øyvind

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Abstract

We examine the risk-return characteristics of a rolling portfolio investment strategy where more than six thousand Nasdaq initial public offering (IPO) stocks are bought and held for up to five years. The average long-run portfolio return is low, but IPO stocks appear as ‘longshots’, as five-year buy-and-hold returns of 1000% or more are somewhat more frequent than for non-issuing Nasdaq firms matched on size and book-to-market ratio. The typical IPO firm is of average Nasdaq market capitalization but has relatively low book-to-market ratio. We also show that IPO firms exhibit relatively high stock turnover and low leverage, which may lower systematic risk exposures. To examine this possibility, we launch an easily constructed ‘low minus high’ (LMH) stock turnover portfolio as a liquidity risk factor. The LMH factor produces significant betas for broad-based stock portfolios, as well as for our IPO portfolio and a comparison portfolio of seasoned equity offerings. The factor-model estimation also includes standard characteristics-based risk factors, and we explore mimicking portfolios for leverage-related macroeconomic risks. Because they track macroeconomic aggregates, these mimicking portfolios are relatively immune to market sentiment effects. Overall, we cannot reject the hypothesis that the realized return on the IPO portfolio is commensurable with the portfolio’s risk exposures, as defined here.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4832.

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Date of creation: Jan 2005
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Handle: RePEc:cpr:ceprdp:4832

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Related research
Keywords: asset pricing; capital structure; Initial Public Offering (IPO); liquidity; market efficiency; risk and return;

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Find related papers by JEL classification:
G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G20 - Financial Economics - - Financial Institutions and Services - - - General
G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Eckbo, B. Espen & Norli, Øyvind, 2004. "The choice of seasoned-equity selling mechanism: Theory and evidence," Discussion Papers 2004/17, Department of Finance and Management Science, Norwegian School of Economics and Business Administration. [Downloadable!]
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  2. Matt Pritsker, 2005. "A Fully-Rational Liquidity-Based Theory of IPO Underpricing and Underperformance," Computing in Economics and Finance 2005 414, Society for Computational Economics. [Downloadable!]
  3. Matthew Pritsker, 2006. "A fully-rational liquidity-based theory of IPO underpricing and underperformance," Finance and Economics Discussion Series 2006-12, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  4. Miguel A. Acedo & Fco. Javier Ruiz & Rafael Santamaría, 2008. "Influence of Secondary Offerings on the Liquidity and Trading Activity of Stocks Outstanding," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 58(01-02), pages 21-37, January. [Downloadable!]
  5. Evgeny Lyandres & Le Sun & Lu Zhang, 2005. "Investment-Based Underperformance Following Seasoned Equity Offerings," NBER Working Papers 11459, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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