The diversification effects of initial public offerings

Hsuan Chi Chen, Keng Yu Ho, Yu Jen Hsiao, Cheng Huan Wu

Research output: Contribution to journalArticle

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.

Original languageEnglish
Pages (from-to)171-205
Number of pages35
JournalJournal of Business Finance and Accounting
Volume37
Issue number1-2
DOIs
Publication statusPublished - Jan 1 2010
Externally publishedYes

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Keywords

  • Initial public offerings
  • Investment opportunity set
  • Mean-variance spanning test

ASJC Scopus subject areas

  • Accounting
  • Business, Management and Accounting (miscellaneous)
  • Finance

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