The Variability of IPO Initial Returns

Michelle B. Lowry

Penn State University, University Park, PA 16082

Micah S. Officer

University of Southern California, Los Angeles, CA 90089

G. William Schwert

University of Rochester, Rochester, NY 14627
and National Bureau of Economic Research

First Draft: May 2006
Current Draft: February 2008

The monthly volatility of IPO initial returns is substantial, fluctuates dramatically over time, and is considerably larger during “hot” IPO markets. Consistent with IPO theory, the volatility of initial returns is higher among firms whose value is more difficult to estimate, i.e., among firms with higher information asymmetry. Interpreting initial return volatility (or dispersion) as a measure of pricing (or forecast) errors made by underwriters, we conclude that underwriters have considerable difficulty pricing new issues accurately. Moreover, the complexity of the valuation problem is greater during “hot” IPO markets and for firms with high information asymmetry. One implication of our results is that the bookbuilding process may be inferior to alternate price discovery mechanisms in the pre-IPO period, and that alternate mechanisms, such as auctions, may be beneficial to firms that value price discovery.

Key words: IPO, Underpricing, Cycles, Information Asymmetry, Conditional Heteroskedasticity, Volatility

JEL Classifications: G32, G24, G14

© Copyright 2006-2007, Michelle Lowry, Micah S. Officer, and G. William Schwert
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