An Answer to the Long-Run Performance Puzzle of IPOs in Taiwan: An Application of the Fama-French Model

Abstract

Prior research on initial public offerings (IPOs) emphasizes on the underpricing of IPOs. For the long-run performance of IPOs, Ritter (1991) and Loughran and Ritter (1995) argue that the long-run performance of IPOs is worse than that of the overall market or that of the firms with the matched size and age. Through backward induction, no one will purchase IPO shares once he realizes that he will suffer losses in the long run. This paper focuses on the measure of the long-run performance of IPOs. Typically, the capital asset pricing model (CAPM) which implies that beta is the only risk factor for the asset return is employed to measure the expected return on assets. However, Fama and French (1992, 1993, 1995, 1996) argue that the size related factor, book-to-market related factor along with the market risk are more powerful to describe asset returns. This study employs the Fama-French three-factor model as well as Jensen!?s alpha to measure the long-run performance of IPOs. Our results show that the long-run performance of IPOs based on market adjusted returns or returns adjusted by market model is poor which is consistent with the findings in Ritter (1991). However, the long-run performance based on Fama-French three-factor model is fluctuating around zero, which is the normal return pattern for an ordinary asset. Therefore, we conclude that the underperformance of IPOs is attributed to the mis-specification of the measurement model.