LIQUIDITY AND RETURNS OF UNDERPRICED IPO STOCKS IN THE SECONDARY MARKET

Abstract

Offering stocks below their market value (underpricing) is a common phenomenon of the Initial Public Offering (IPO). Issuers expect that underpricing keep their stocks attractive to investors (thus, more liquid and more disbursed stocks ownership). Investors, the party involved in stocks trading, may have different expectation; they want to gain profit from the purchase of the low price IPO stocks. This paper will examine if the underpriced IPO stocks improve both the liquidity and returns. The data include underpriced IPO stocks offered during 1998–2005 at the Indonesia Stock Exchange (BEI). Stocks performance will be recorded subsequently 3 (three) years after the IPO, divided into 4 (four) periods. Then, the regressions are applied on: (a) various measures of liquidity as a function of underpricing and other factors, and (b) returns (cumulative adjusted returns) as a function of underpricing, liquidity and other factors. The results show that underpricing improves stocks performance for very short time, i.e., until Period 2 (61-180 days after the IPO) on the liquidity, and until Period 1 (60 days after the IPO) on the returns. The less liquid stocks—held by investors with longer term horizon— may not compensate the investors accordingly.