The "Hot Issue" Market of 1980

Abstract

During the 15-month period commencing in January 1980, the mean return on initial public offerings of common stock purchased at the offering price and sold at the closing bid price on the first day of public trading was 48.4%. This is in contrast to a mean return on initial public offerings of 16.3% during the remainder of the 6-year period 1977-82. This market for initial public offerings was not an isolated event. As first documented by Jbbotson and Jaffe (1975), there have been a number of periods over the last 2 decades in which initial public offerings of common stock have had extremely high returns. Why do these hot issue markets occur? In this paper, I develop an implication of Rock's (1982) model of the underpricing of initial public offerings that can explain this phenomenon. In this model, some types of unseasoned new issues are underpriced more, in an expected-value sense, than others. In particular, high-risk initial public offerings are underpriced more than low-risk ofThis paper analyzes the market of 1980, the 15-month period starting in January 1980 and extending through March 1981 during which the average initial return on unseasoned new issues of common stock was 48.4%. (This is not an annualized return.) This average initial return compares with an average of 16.3% during the cold market comprising the rest of the 1977-82 period. An equilibrium explanation for this difference in average initial returns is investigated but is found to be insufficient. Instead, this hot issue market is found to be associated almost exclusively with natural resource issues. For firms in other industries, a hot issue market is barely perceptible. *1 am grateful to Joe Mazzotti, Jeff Sams, and John Vilot for outstanding research assistance. Useful comments on earlier drafts were received from Jeff Jaffe, Don Keim, Kevin Rock, Robert Stambaugh, an anonymous referee, participants in seminars at New York University, the University of Michigan, and the University of Pennsylvania, and especially from Harry DeAngelo. This work was partially supported by a grant from the Zweig Forecast. I am solely responsible for all errors of omission or commission, however.