Illiquidity Based Factor Construction in Asset Pricing: An Analysis on Long Run Performance of Sri Lankan Initial Public Offering Stocks

T.C Ediriwickrama,A.A Azeez

doi:10.4038/cbj.v8i1.10

Abstract

IPO long run underperformance is a widely debated anomaly in corporate finance literature. Present study inquires whether above anomaly exists even after pricing for well known risk factors constructed based on size as well as illiquidity. This study proposed a new illiquidity based four factor asset pricing model and tested it using Sri Lankan initial public offering (IPO) stocks in inter war period and post war period. Proposed model was compared with Carhart (1997) four factor model. Both ordinary least square regression and weighted least square regression have been used to test Carhart’s model and proposed model in Sri Lankan context. It is found that long run IPO underperformance anomaly existed even after pricing for the illiquidity premium. Further two models perform very similarly and it is not fair to say one is superior to the other.

Highlights

Capital market plays an important role in the modern economy of any country the economic development of the country
SMB, HML and WML are replaced by SIZEILL, BTMILL and MOMILL respectively
When EWRI-RF is used as the dependent variable, initial public offering (IPO) stock portfolio underperformed in proposed illiquidity based four factor model for a full period and interwar period

Summary

Introduction

Capital market plays an important role in the modern economy of any country the economic development of the country. One of the main purposes of this paper is to find out whether IPO long run stock price underperformance anomaly exists even after accounting for illiquidity based risk factors. Ediriwickrama and Azeez (2015) analyzed Sri Lankan IPO long run performance using multi factor models under calendar time approach and found IPO stock portfolio resulted significant negative returns. Further they found beta is significantly positive among Sri Lankan IPO stocks. In this study authors attempted to replace firm size with illiquidity and compare the results using an IPO stock portfolio in emerging Sri Lankan market. Risk free rate is taken as three month Treasury bill rate published by central bank of Sri Lanka (CBSL)

Methodology

Findings

Conclusion