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RFS Advance Access published online on January 20, 2006
Review of Financial Studies, doi:10.1093/rfs/hhj018
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© The Author 2006. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org

Article

IPO underpricing and after-market liquidity

Andrew Ellul 1 * and Marco Pagano 2
1 Kelley School of Business, Indiana University
2 Università di Napoli Federico II, CSEF and CEPR

* To whom correspondence should be addressed.
Andrew Ellul, E-mail: anellul{at}indiana.edu


  Abstract

The underpricing of Initial Public Offerings (IPOs) is generally explained with asymmetric information and risk. We complement these traditional explanations with a new theory where investors worry also about the after-market illiquidity that may result from asymmetric information after the IPO. The less liquid the after-market is expected to be, and the less predictable its liquidity, the larger will be the IPO underpricing. Our model blends such liquidity concerns with adverse selection and risk as motives for underpricing. The model’s predictions are supported by evidence for 337 British IPOs effected between 1998 and 2000. Using various measures of liquidity, we find that expected after-market liquidity and liquidity risk are important determinants of IPO underpricing.

Keywords: liquidity, post-IPO market, after-market trading, initial public offering.
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