Empirical Research On The Impact Of Issue Price Inquiry And Noise Trading To The Abnormal Return Of China's Initial Public Offering

The abnormal return in the first day of stock Initial Public Offering (IPO) has always been a puzzle in financial market, which is more prominent in China's IPO market. The traditional asymmetric information theory can't not explain the puzzle in China well, then some scholars attributed the abnormal initial return to the administrative control on the issue PE (price/earning ratio) of new share. China introduced the issue price inquiry system in 2005, which contributed a lot to the marketization of issue price of stock.The price inquiring process doesn't control issue PE no longer, and lowers the degree of asymmetric information; the underwriter also adjusts fully to the information collected in the inquiry process, which will lower the IPO abnormal initial return in theory. However, we found that the initial returns didn't significantly reduce after the implementation of inquiry system. Therefore, we believe that the high abnormal initial return must result from the noise trading in the secondary market. To confirm our inference above, we test the 1-year performance after the IPO. We find that the long term performance of new shares are significantly lower than the stock index, and the higher the initial return is, the worse the long-term performance, which prove the existence of noise trading in the secondary market. Specifically, we conclude that the investors'optimist sentiment and the positive feedback trading strategy they takes will result in the high initial abnormal return. Specifically, we believe that the secondary market price-earning ratio of comparable companies is the benchmark of noise traders, the higher the PE of comparable company relative to issuing PE, the greater increasing scope for the new share, which means the higher risk tolerance of noise traders and the abnormal initial return.In short, the issue price inquiry system significantly improves the issue PE of the new share, but fails to fundamentally reduce the abnormal initial return of it. We believe that the noise trading in secondary market is the underlying cause, which maybe result from the limited number of the stock for trading.