Question

A wealthy statistician observes that the average first trading day return for IPO issues is significantly greater than zero. For the purpose of making money, the statistician proposes to place $10,000 order for each IPO issue to be traded on the NYSE next year and sell the purchased stock at the end of the first trading day. Do you agree or disagree her investment strategy? Why?

Answer 1

I disagree with this strategy for these reasons :

Probability of allotment is less than 1. Placing an order for an IPO issue does not guarantee allotment of the shares. Most IPOs are oversubscribed. Considering this, and the number of IPO issues in a year, the profits this strategy will not be significant, even though the average first day trading return for IPO issues is significantly greater than zero.

Also, in an efficient market and a widely traded exchange like NYSE, no strategy should be able to generate excess risk adjusted returns. Hence, according to the theory of efficient markets, this strategy should not be able to generate superior returns.