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The Diversification Effects of Initial Public Offerings

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  • Hsuan‐Chi Chen
  • Keng‐Yu Ho
  • Yu‐Jen Hsiao
  • Cheng‐Huan Wu

Abstract

A firm's stock becomes publicly tradable through an initial public offering (IPO). This study suggests a portfolio diversification perspective to explore IPOs. We examine whether investors can gain diversification benefits by adding an IPO portfolio to a set of benchmark portfolios sorted by firm size and book‐to‐market ratio. Using US IPOs from 1980‐2002, we find that adding a value‐weighted IPO portfolio does lead to a statistically and economically significant enlargement of the investment opportunity set for investors relative to investing solely in a set of benchmark portfolios. Specifically, the Sharpe ratio of the tangency portfolio increases by 5.50% on average after including IPO stocks. Furthermore, IPOs associated with prestigious lead underwriters are the main source of this augmentation of the mean‐variance investment opportunity set. Finally, our study implies that issuing IPO exchange traded funds or similar products can provide diversification gains to investors.

Suggested Citation

  • Hsuan‐Chi Chen & Keng‐Yu Ho & Yu‐Jen Hsiao & Cheng‐Huan Wu, 2010. "The Diversification Effects of Initial Public Offerings," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 37(1‐2), pages 171-205, January.
    • Handle: RePEc:bla:jbfnac:v:37:y:2010:i:1-2:p:171-205
    DOI: 10.1111/j.1468-5957.2009.02177.x
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