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JOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS

VOL. 39, NO. 3, SEPTEMBER 2004

COPYRIGHT 2004, SCHOOL OF BUSINESS ADMINISTRATION, UNIVERSITY OF WASHINGTON, SEATTLE, WA 98195

Initial Public Offerings in Hot and Cold Markets
Jean Helwege and Nellie Liang£

Abstract
The literature offers many explanations for why the IPO market cycles from hot to cold. These include theories in which hot markets represent clusters of IPOs in a new industry, and signaling models that predict that hot markets draw in better quality firms. Others suggest hot market IPOs’ stock returns reflect their poor quality. We compare IPOs over cycles during 1975–2000 and find that hot and cold IPO markets do not differ so much in the characteristics of the firms that go public as in the quantity of firms that go public. Both hot and cold IPOs are largely concentrated in the same narrow set of industries and they have few distinctions in profits, age, or growth potential. Our results suggest that hot markets are not driven primarily by changes in adverse selection costs, managerial opportunism, or technological innovations, but more likely reflect greater investor optimism.

I. Introduction
The initial public offering (IPO) market has exhibited dramatic swings in issuance that are often referred to as hot and cold markets (see Ibbotson and Jaffe (1975) and Ritter (1984)). Hot IPO markets have been described as having an unusually high volume of offerings, severe underpricing, frequent oversubscription of offerings, and (at times) concentrations in particular industries.1 In contrast, cold IPO markets have much lower issuance, less underpricing, and fewer instances of oversubscription. Furthermore, Loughran, Ritter, and Rydqvist (1994), £ Helwege, helwege 1@cob.osu.edu, Department of Finance, University of Arizona, Tucson, AZ 85721; and Liang, nliang@frb.gov, Board of Governors of the Federal Reserve System, Division of Research and Statistics, Capital Markets Section, Mail Stop 89, Washington, DC 20551. We are grateful for helpful suggestions from Peter Antunovich, Arturo Bris, Natasha Burns, Walid Busaba, Michael Fleming, Kewei Ho, David Ikenberry, Jan Jindra, Kose John, Jonathan Karpoff (the editor), Rodolfo Martell, Frank Packer, Katherine Spiess, Ren´ Stulz, Ivo Welch (associate editor and referee), e and seminar participants at the University of North Carolina, the First Yale SOM Conference on Young Firms, the Federal Reserve Bank of New York, the 1996 Financial Management Association, and Ohio State University. Kyle Nagel, Philibert De Imus, Eric Richards, Kevin Cole, Kin Cheng, Vhan Tran, Niki Boyson, Lizy Mathai, Andy Fedak, Scott Hively, Guang Yang, and Tom McAndrew provided excellent research assistance. The analysis and conclusions of this paper are those of the authors and do not indicate concurrence by other members of the research staff, by the Board of Governors, or by the Federal Reserve System. 1 For example, Ritter (1984) shows that most of the underpricing in the hot issue market of 1980– 1981 is attributable to IPOs in the natural resources sector. Also, see Lowry and Schwert (2002) on the relationship between underpricing and volume in hot and cold markets, as well as James and Kieschnick (1997).

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p. 175 note a “clear tendency for high [IPO] volume to be associated with [stock] market peaks ” The IPO literature offers a variety of opinions about how hot and cold market firms might differ. These include theoretical models that focus on underpricing as a signaling mechanism, empirical studies on the long-term performance of IPOs, and models of the decision to go public or remain private. The signaling models characterize hot markets as periods when a greater number of high quality firms choose to go public (Allen and Faulhaber (1989), Grinblatt and Hwang (1989), and Welch (1989)). In these models, firms are drawn into hot markets because offer prices are less affected...
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