Underpricing and actual return in IPOs

Abstract

In IPOs, both the firm and its underwriter might have incentives to underprice the shares. This has caused a perception that investing in IPOs is an easy way to achieve abnormal returns. According to an article published by Kevin Rock however, investors should not expect abnormal returns when subscribing for shares in IPOs after adjusting for expected rationing. He refers it to a winner’s- curse problem where investors gets full allocation in overpriced IPOs and limited allocation in underpriced ones. We attacked this issue to investigate whether the expected return in an IPO is in fact positive after adjusting for expected allocation. We found that the unadjusted return between 1994 and 2016 was substantially high but after adjusting for expected allocation, the return dropped dramatically. Our result did not allow us to reject that the expected return when subscribing for shares in an IPO might in fact be zero.