This paper examined the returns earned by subscribing to initial public offerings of equity (IPOs). Rock (1986) suggests that IPO returns are required by uninformed investors as compensation for the risk of trading against superior information. We show that IPOs with more informed investor capital require higher returns. The marketing underwriter's reputation reveals the expected level of "informed" activity. Prestigious underwriters are associated with lower risk offerings. With less risk there is less incentive to acquire information and fewer informed investors. Consequently, prestigious underwriters are associated with IPOs that have lower returns. AN INITIAL PUBLIC OFFERING (IPO) is the first effort by private firms to raise capital in a public equity market. Previous research shows that, on average, the difference between the IPO subscription price and the first secondary market price is greater than a "reasonable" risk premium would require. Thus, it appears that issuing firms and underwriters are deliberately underpricing their IPOs.Several We would like to acknowledge the useful comments of our colleagues Sanjai Bhagat, Jeff Coles, Dick Jefferis, Uri Lowenstein, and Jay Ritter. Our interactions with Dick Jefferis in particular helped to identify and clarify several critical issues. We would also like to thank Jay Ritter for the provision of data. Support from the University of Utah Graduate School of Business, the Garn Institute of Finance, and Iowa State University is gratefully acknowledged. Substantial technical assistance was provided by Denise Woodbury. We would also like to thank the staff at the Chicago Library of Arthur Andersen and Company for their assistance. We alone are responsible for any errors or omissions.1 For a review of empirical research as well as an overview of the IPO process, see Though our model has been influenced by all of this antecedent literature, it is most similar to the model of Rock (1986) and its extension by Beatty and Ritter (1986) (see especially the appendix to their paper). Rock (1986) argues that IPO underpricing compensates uninformed investors for the risk of trading against superior information. In our model, consistent with Rock, the greater the proportion of informed investor capital participating in an IPO, the greater is the equilibrium underpricing. If investors have scarce resources to invest in information acquisition, they specialize in acquiring information for the most uncertain investments. Since informed investor capital migrates to the highly uncertain IPOs, the underpricing and subsequent price run-up for these firms are greater.Underpricing is costly to the issuing firm. Therefore, low risk firms attempt to reveal their low risk characteristic to the market. One way they can do this is by selecting underwriters with high prestige. In this paper, we provide empirical evidence that supports our theoretical result that underwriter prestige is associated with the marketing of low risk IPOs. The empirical analysis is facilitated by our dev...

This paper examined the returns earned by subscribing to initial public offerings of equity (IPOs). Rock (1986) suggests that IPO returns are required by uninformed investors as compensation for the risk of trading against superior information. We show that IPOs with more informed investor capital require higher returns. The marketing underwriter's reputation reveals the expected level of "informed" activity. Prestigious underwriters are associated with lower risk offerings. With less risk there is less incentive to acquire information and fewer informed investors. Consequently, prestigious underwriters are associated with IPOs that have lower returns. AN INITIAL PUBLIC OFFERING (IPO) is the first effort by private firms to raise capital in a public equity market. Previous research shows that, on average, the difference between the IPO subscription price and the first secondary market price is greater than a "reasonable" risk premium would require. Thus, it appears that issuing firms and underwriters are deliberately underpricing their IPOs.Several We would like to acknowledge the useful comments of our colleagues Sanjai Bhagat, Jeff Coles, Dick Jefferis, Uri Lowenstein, and Jay Ritter. Our interactions with Dick Jefferis in particular helped to identify and clarify several critical issues. We would also like to thank Jay Ritter for the provision of data. Support from the University of Utah Graduate School of Business, the Garn Institute of Finance, and Iowa State University is gratefully acknowledged. Substantial technical assistance was provided by Denise Woodbury. We would also like to thank the staff at the Chicago Library of Arthur Andersen and Company for their assistance. We alone are responsible for any errors or omissions.1 For a review of empirical research as well as an overview of the IPO process, see Though our model has been influenced by all of this antecedent literature, it is most similar to the model of Rock (1986) and its extension by Beatty and Ritter (1986) (see especially the appendix to their paper). Rock (1986) argues that IPO underpricing compensates uninformed investors for the risk of trading against superior information. In our model, consistent with Rock, the greater the proportion of informed investor capital participating in an IPO, the greater is the equilibrium underpricing. If investors have scarce resources to invest in information acquisition, they specialize in acquiring information for the most uncertain investments. Since informed investor capital migrates to the highly uncertain IPOs, the underpricing and subsequent price run-up for these firms are greater.Underpricing is costly to the issuing firm. Therefore, low risk firms attempt to reveal their low risk characteristic to the market. One way they can do this is by selecting underwriters with high prestige. In this paper, we provide empirical evidence that supports our theoretical result that underwriter prestige is associated with the marketing of low risk IPOs. The empirical analysis is facilitated by our dev...

This paper examined the returns earned by subscribing to initial public offerings of equity (IPOs). Rock (1986) suggests that IPO returns are required by uninformed investors as compensation for the risk of trading against superior information. We show that IPOs with more informed investor capital require higher returns. The marketing underwriter's reputation reveals the expected level of "informed" activity. Prestigious underwriters are associated with lower risk offerings. With less risk there is less incentive to acquire information and fewer informed investors. Consequently, prestigious underwriters are associated with IPOs that have lower returns. AN INITIAL PUBLIC OFFERING (IPO) is the first effort by private firms to raise capital in a public equity market. Previous research shows that, on average, the difference between the IPO subscription price and the first secondary market price is greater than a "reasonable" risk premium would require. Thus, it appears that issuing firms and underwriters are deliberately underpricing their IPOs.Several We would like to acknowledge the useful comments of our colleagues Sanjai Bhagat, Jeff Coles, Dick Jefferis, Uri Lowenstein, and Jay Ritter. Our interactions with Dick Jefferis in particular helped to identify and clarify several critical issues. We would also like to thank Jay Ritter for the provision of data. Support from the University of Utah Graduate School of Business, the Garn Institute of Finance, and Iowa State University is gratefully acknowledged. Substantial technical assistance was provided by Denise Woodbury. We would also like to thank the staff at the Chicago Library of Arthur Andersen and Company for their assistance. We alone are responsible for any errors or omissions.1 For a review of empirical research as well as an overview of the IPO process, see Though our model has been influenced by all of this antecedent literature, it is most similar to the model of Rock (1986) and its extension by Beatty and Ritter (1986) (see especially the appendix to their paper). Rock (1986) argues that IPO underpricing compensates uninformed investors for the risk of trading against superior information. In our model, consistent with Rock, the greater the proportion of informed investor capital participating in an IPO, the greater is the equilibrium underpricing. If investors have scarce resources to invest in information acquisition, they specialize in acquiring information for the most uncertain investments. Since informed investor capital migrates to the highly uncertain IPOs, the underpricing and subsequent price run-up for these firms are greater.Underpricing is costly to the issuing firm. Therefore, low risk firms attempt to reveal their low risk characteristic to the market. One way they can do this is by selecting underwriters with high prestige. In this paper, we provide empirical evidence that supports our theoretical result that underwriter prestige is associated with the marketing of low risk IPOs. The empirical analysis is facilitated by our dev...

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The Black-Scholes option pricing model, modified for dividend payments, is used to calculate jointly implied stock prices and implied standard deviations. A comparison of the implied stock prices with observed stock prices reveals that the implied prices contain information regarding equilibrium stock prices that is not fully reflected in observed stock prices. The implications of this finding are discussed. THIS STUDY INVESTIGATES THE role of call option prices as predictors of the equilibrium prices of their underlying stocks using the Black-Scholes [3] (BS) model. Previous tests of the BS model have shown that the formula is highly successful in explaining the observed market prices of options (see Black and Scholes [2], Galai [8], Chiras and Manaster [6], and Macbeth and Merville [12]. According to the model, the option price is a function of the current value of the underlying stock, the instantaneous variance of the stock's rate of return, the time to maturity of the option, the risk-free rate of interest, and the exercise price of the option.1 Given an observed option price and known values of all input parameters to the BS model except the stock price, one can determine the price of the underlying stock that equates the observed option price to its calculated value. It follows from the underlying logic of the model that the implied price is the value of the underlying stock for which a continuously revised option-bond portfolio would be a perfect substitute for the stock. Hence, if options are actually priced according to the model, implied stock prices will be the option market's assessment of equilibrium stock values.Previous empirical studies have assumed that observed stock prices are the relevant stock prices for option valuation. However, just as stock prices may differ, in the short run, from one exchange to another (i.e., NYSE, Midwest, Wake Forest University. In addition, we owe a special thanks to Jonathan Ingersoll, the Editor, Michael Brennan, and James D. MacBeth. 'The Black-Scholes model assumes that the underlying stock pays no dividends. No closed form solution has been obtained, however, for pricing American call options on dividend paying stocks. The problem has been solved numerically by Brennan and Schwartz [5], Rubinstein and Cox [18], and Rendleman and Bartter [16]. Roll [17] has derived an analytical solution to the problem of pricing options on dividend paying stocks. However, his model requires knowledge of a critical stock price which must be determined numerically. 1043 1044The Journal of Finance Pacific, Philadelphia, etc.), the stock prices implicit in option premia may also differ from the prices observed in the various markets for stock. In the long run, the trading vehicle that provides the greatest liquidity, the lowest trading costs, and the least restrictions is likely to play the predominant role in the market's determination of the equilibrium values of underlying stocks. In principle, there is nothing to prohibit the options market from playing an important role, if n...