The Persistence of IPO Mispricing and the Predictive Power of Flipping

Despite underwriters\u27 efforts to balance supply and demand in the IPO price setting mechanism, we show that the market accurately predicts (in the first-day return and volume) the direction but not the full magnitude of underwriters\u27 pricing errors. That is, first-day winners continue to be winners on average (outperforming a size-adjusted benchmark) over the first year, and first-day dogs continue to be relative dogs . A trading rule of buy first-day solid performers beginning at the close of the IPO\u27s second trading day outperforms the portfolio of first-day losers by about 14% in the next year during the 1988-1995 time period. An exception to this rule is the performance of extra- hot IPOs (with a first-day return greater than 50 to 60%) which are poor one-year performers on average. We also find that a measure of flipping, the dollar volume of sell-motivated block trades as a percent of total dollar volume on the first-day, has significant power to predict future returns, lending credence to investors\u27 flipping of cold IPOs as a rational strategy. Furthermore, we show that first-day flipping can be predicted from ex ante factors. Thus, we conclude that underwriters\u27 pricing errors at both extremes (initial cold and very hot IPOs) are intentional and strategic

The Persistence of IPO Mispricing and the Predictive Power of Flipping

This paper examines underwriters' pricing errors and the information content of first-day trading activity in IPOs. We show that first-day winners continue to be winners over the first year, and first-day dogs continue to be relative dogs. Exceptions are "extra-hot" IPOs, which provide the worst future performance. We also demonstrate that large, supposedly informed, traders "flip" IPOs that perform the worst in the future. IPOs with low flipping generate abnormal returns of 1.5 percentage points per month over the first six months beginning on the third day. We show that flipping is predictable and conclude that underwriters' pricing errors are intentional. Copyright The American Finance Association 1999.