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IPO underperformance and the idiosyncratic risk puzzle

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  • Chen, Honghui
  • Zheng, Minrong

Abstract

We investigate the relationship between IPO long-run underperformance (Ritter, 1991; Loughran and Ritter, 1995) and the idiosyncratic risk puzzle (Ang, Hodrick, Xing, and Zhang, 2006) or the phenomenon of abnormally low returns for stocks with high idiosyncratic risk. We find that IPO long-run underperformance is a manifestation of surprisingly low returns for high idiosyncratic risk stocks. IPO underperformance disappears after we control for idiosyncratic risk. On the other hand, we find that the idiosyncratic risk puzzle is magnified by IPO underperformance. Our results are robust to various specifications or sample requirements. We evaluate a couple of potential common causes for the two puzzles and conclude that investors’ preferences for stocks with lottery features is the primary mechanism linking the two puzzles.

Suggested Citation

  • Chen, Honghui & Zheng, Minrong, 2021. "IPO underperformance and the idiosyncratic risk puzzle," Journal of Banking & Finance, Elsevier, vol. 131(C).
    • Handle: RePEc:eee:jbfina:v:131:y:2021:i:c:s0378426621001497
    DOI: 10.1016/j.jbankfin.2021.106190
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    Keywords

    Idiosyncratic risk puzzle; IPO underperformance;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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