An empirical assessment of initial return volatility in newly listed stocks

ABSTRACT

A stock’s first month of listing or ‘seasoning’ is often characterized by sharp volatility in initial returns. Such volatility is likely to be even more pronounced in initial public offering (IPO) markets where retail investors exert significant influence. I consider initial return volatility for IPOs pitched in Hong Kong, where the market organizer requires a sizeable fraction of shares on offer to be assigned to a retail subscription tranche. Within this context, I examine the pattern and determinants of IPO stocks’ initial return volatility levels over their first 30 days of ‘seasoning’. I observe that IPO underpricing, market sentiment and float size figure as key explanatory factors. Results also reaffirm the importance of information asymmetry effects (Ritter, 1984; Beatty and Ritter, 1986; and Lowry et al., 2010). Larger IPO firms with tighter offer price spreads and more reputable underwriters exhibit noticeably greater price stability. I also assess Ljungqvist, Nanda and Singh’s (2006) proposition that underpricing in ‘hot’ IPOs protects issuers and subscribers against a subsequent fall-off in issuer sentiment. Via analysis of retail tranche share allotments, I meaningfully extend findings (Jiang and Li, 2013) in this area.

KEYWORDS:

• IPOs
• initial return volatility
• price uncertainty

JEL CLASSIFICATION:

• G14
• G30
• G32

Disclosure statement

I assert that there are no conflicts of interest in relation to this article.

Notes

¹ Rule 4.2 of Practice Note 18 (2013; Hong Kong Exchanges and Clearing Limited (HKEx) MB Listing Rules) requires an ‘initial’ RT allocation of 10% of IPO shares. Rule 4.2 also governs claw-backs, though waivers may apply. RT subscription rates ≥ 100 require RT allocations to rise to 50%.

² The correlation they report (p. 78) of −0.0038 relates to the first day open–close return and is not statistically significant. They report that both flows bear significant positive correlation when pre- to post-sentiment remains ‘high’.

³ It is akin to Ritter’s (1984) ‘ex-post uncertainty’ measure (see Falconieri, Murphy, and Weaver 2009, 293, for ex-post proxies).

⁴ For useful review, see Jog and Wang (2009, 232). HK-based evidence also suggests a link between volatility and retail subscription rates (see Vong 2006; and McGuinness 2009).

⁵ The present study does not consider post-IPO firm performance (see McGuinness 2014b for recent assessment of long-run accounting and stock returns).

⁶ They focus on the variability of issuers’ initial 21-day holding returns for months of varying IPO activity. They also indicate (p. 452–3) some level of consistency with Pastor and Veronesi (2005).

⁷ Gross proceeds may serve as an ex-ante uncertainty proxy (see Falconieri, Murphy, and Weaver 2009, 287).

⁸ See Mazouz et al. (2013) and McGuinness (2014a) for discussion of arrangements governing stabilization in HK.

⁹ Variable has mean 56.25% and SD 36.72% (n = 269). To illustrate, see Country Garden’s IPO Allotment Results announcement, 19/04/07, Summary, p. 5, ‘Basis of Allotment’: http://www.hkexnews.hk/listedco/listconews/SEHK/2007/0419/02007/EW102.pdf. Alloc is 25% in this case, for applications of 1000 shares in RT ‘Pool A’.