The Diversification Effects of Initial Public Offerings |
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| Authors: | Hsuan-Chi Chen Keng-Yu Ho Yu-Jen Hsiao and Cheng-Huan Wu |
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| Institution: | The authors are respectively from University of New Mexico, National Taiwan University, National Central University, and Yuan Ze University. They thank the editor, Martin Walker, and an anonymous referee for very helpful comments. They are grateful to Jacqueline Garner, Jason Karceski, Xi Li, Richard Pettway, Josef Schuster, Hsiu-Chuan Yeh, and especially Jay Ritter for valuable suggestions. The paper also has benefited from comments from the conference participants at the 2004 NTU International Conference on Finance, 2004 SFM Conference, 2005 TFA Annual Meeting, 2006 CICF Conference, 2006 FMA Annual Meeting, and 2007 International Financial Planning Conference and CEO Forum, and seminar participants at Arizona State University, Phoenix, California State University, Los Angeles, Ching-Yun University, Fu-Jen Catholic University, National Central University, National Cheng-Chi University, National Chiao-Tung University, National Taiwan University, Penn State University, Harrisburg, Shih-Hsin University, University of Florida, University of Houston, Downtown, and University of New Mexico. |
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| Abstract: | 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. |
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| Keywords: | initial public offerings investment opportunity set mean-variance spanning test |
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