Hot and Cold Market Cycle and IPO Performance: Theory and Evidence

Abstract

The study develops a theoretical model, which describes the mechanism and causation of hot and cold market and their relationship to IPO underpricing. Empirical tests are conducted on a sample of 1,382 IPOs issued in the United States from 1st January 1988 to 30th June 1999. The empirical tests examine the propositions derived from the model, namely underpricing behavior and role of risk premium factor as well as risk-free interest rates in the hot and cold markets. The study demonstrates that interest rates and bond rating spread are highly correlated to the hot/cold markets thus can be used as a proxy of hot/cold market cycle. The study concludes that both interest rate and percentage of underpriced issues in the cold market are significantly higher than that in the hot market. It is also concluded that underpricing is higher in the hot market than in the cold market.