The long-run performance of Italian initial public offerings

Financial markets are sometimes affected by anomalies, i.e. return behaviors that deviate from what a rational asset pricing model would predict. These are interesting objects of study because they are some sort of “gray area”, difficult to explain from an efficient market hypothesis perspective. While there are some studies which nonetheless try to do so, others build new theories which explain these phenomenons with a completely different approach, by introducing cognitive psychology and bounded rationality into the discussion, and thus contributing to the behavioral finance related literature, started by Kahneman & Tversky in 1979. One of the most debated anomalies is the IPO long run underperformance anomaly, ini- tially evidenced in the 70’s but mostly researched upon in the past 20 years, after Jay Ritter seminal study in 1991. The unexpected behavior which makes this an anomaly is the follow- ing: initial public offerings seem to consistently (in different periods and different markets) underperform the chosen benchmark (usually a market index or a size, industry or book to market matched-firms portfolio). Brokers often joke about how the term IPO might as well stand for “It’s probably overpriced”, meaning that the initial evaluation investors make of the stock is excessive, and that only subsequently the price slowly reaches its fundamental value. This work addressed the anomaly with a specific focus on the Italian market, by mea- suring long run abnormal returns with respect to two different benchmarks: the Morgan Stanley MTSCI index and a size and industry matched-firms portfolio. Results show that indeed Italian IPOs underperform in the 3 years which follow the offering; the market index comparison approach showed a 36-month CAR of -5.83% and 36-month BHAR of -5.22%; the size and industry matched firms approach yielded a 36-month CAR of -12.68% and 36-month BHAR of -8.58%. Along with these measurements, also value weighted portfolio calendar time analysis were carried out. The second part of the work tried to explain the findings in the light of the divergence of opinion (Miller, 1976) and windows of opportunity (Ritter, 1991) theories. This was done by creating an empirical model able to proxy for market sentiment and growth status of the firm. Results show how firms which go public in periods of high market exuberance (proxied by Baker & Wurlger’s investor sentiment index or by discounts on closed-end funds), firms with low book to market ratios (a proxy for high growth) and firms backed up by a venture capitalist are more likely to underperform in the long run. This is interesting because a measurable variable, the market sentiment index, can help (on average) at choosing whether to invest in an IPO or not.