Uninformed Trading and Information Uncertainty in the Post-IPO Market

Abstract

Underpricing in the initial public offering (IPO) market has been traditionally explained as a means of attracting liquidity traders. We find strong evidence suggesting that the intensity of trading coming from these uninformed traders and the rate of idiosyncratic information arrival play important roles in determining the level of adverse selection cost of trading in the post-IPO market. Timeseries analysis reveals that this cost is lowest immediately post-IPO and it increases monotonically in the first 8–12 weeks of secondary market trading. Order flow variability and the fraction of small trades (both proxies for the extent of uninformed trading) are at their highest in the immediate aftermarket and their levels decay for the next 8–12 weeks. Our results allude to the existence of a negative relationship between underpricing and the adverse selection problem in the post-IPO market, mediated by the intensity of uninformed trading.