Primary Market Characteristics and Secondary Market Frictions of Stocks

Abstract

We analyze the relationship between the primary market characteristics and the secondary market trading frictions of new stocks. We identify major differences across portfolios of IPO stocks grouped by market heat, underpricing, offer price, underwriter prestige, and VC backing. IPOs issued in hot markets, IPOs with low offer price or low reputation underwriters or no VC backing face higher liquidity frictions, higher information constraints, worse short-sale constraints, and higher idiosyncratic risk. Highly underpriced IPO stocks are more liquid, more recognized by analysts and institutional investors, but they have higher idiosyncratic risk, and a higher percentage of them are short-sale constrained. Also, we find an interesting time trend in the evolution of the new stocks' secondary market trading frictions: the mean-reversion of an average IPO stock towards a typical seasoned stock is very slow, and it takes more than a few years. We propose a quality-based explanation for all of the above phenomena.

Keywords: idiosyncratic risk, incomplete information, initial public offerings, liquidity, market frictions, short-sale constraints

JEL Classification: G12, G14, G24, G30