An Empirical Study On First-day Abnormal Return Of Chinese IPO Market

Initial public offering (IPO) is when a company issues common stock or shares to the public for the first time. First-day abnormal return of IPO, which is also referred as Underpricing, is one of the ten mysteries in financial study. Brealey and Myers(1991) found IPO has first-day abnormal return(under-pricing) phenomenon Which became one of the ten mysteries in financial field. There are different explanations on this phenomenon. Levis (1990) researched 712 IPO companies in LSE between 1980 and 1988, found out the average abnormal return on the IPO day is 14.3%. Ellul and Pagona (2006) investigated 337 IPOs in LSE during 1988~2000, also found the average first-day abnormal return is up to 47.7%, which indicates first-day abnormal return has changed over time. Loughran, Ritter and Rydqvist(1994) also demonstrated that first-day abnormal return is also different across countries.In this paper, I first review the literatures on IPO first-day abnormal return, and describes different explanations like information asymmetry, price stabilizing activity, bandwagon effects, and investment bubble.Then I review the offering and auditing mechanism over the world followed by the evolution of Chinese stock market. Nowadays the most popular offering mechanisms are: fixed price offering, book-building offering and auction offering. And the main systems in IPO auditing systems are: examination and approval system, verification and approval system and registration system. Since the publication of"Company Law"and"Securities Law", China has been under book-building and verification and approval system in IPO market.After that, I regress on 155 IPOs (A share) between June, 2006 and Oct. 2007 and 105 IPOs between Nov. 2007 and Sep. 2008 in SSE and SZSE to investigate the major effect factor of China IPO market. Here also I points out that China has a unique variable distinguished with other developed market-time gap between offering day and listing day, which is also a proxy for ex-ante uncertainty. I found out that from 2006-06-19 to 2007-10-09 during which time the stock market was almost always bull market, the underpricing and the time gap shows negative coefficient. This result contradicts research findings about IPO underpricing in China prior to Year 2006 which argue that firms that have a longer delay between the issue of IPO shares and the subsequent listing of those shares, price the IPO cheaply (Gongmeng Chen, Michael Firth and Jeong-Bon Kim, 2003).The explanation to this phenomenon is that individual investors'demand leads to high IPO prices in hot markets. Also according to Wang chun and Yao jin(2002), the overpricing of secondary market is strongly associated with the excess initial return, which is different from the Western countries essentially. The IPOs are overpriced much higher than before or after, and the longer the delay,the worse information with which the IPO company signals the market, thus individual investors don't want to buy the IPO with a higher price, thus the"underpricing"(actually is overpricing) will be less. This is a good proof for that investment bubble hypothesis is most powerful to explain Chinese IPO market phenomenon.I also find that the issuing price is significantly positively related to initial return of the IPO in bull market while in bear market these come out to be opposite. These results are also proves to support that the investors are playing key role in Chinese stock market.Besides, the asymmetric information hypothesis and cascades hypothesis hold for Chinese stock market though latter is not significant during Jun., 2006 and Oct., 2007, which is because of investors'key role in abnormal return of IPO on the first day.The result of the regression during Nov. 2007 and Sep. 2008 shows that bandwagon effects hypothesis is suitable for China IPO markets, and it also tells us that market players- investors in China IPO markets are quite irrational in making decision which is why the China IPO markets are so abnormal. At last, I give out some advices to regularize Chinese stock markets, which are: to regularize underwriter, to guard against aggressive illegal arbitrage behavior, to improve the trading database and improve the macro-control of the regulator and so on.