Briefly explain how semistrong EMH empirical evidence encourage the investors to earn abnormal returns in case of
Question:
Briefly explain how semistrong EMH empirical evidence encourage the investors to earn abnormal returns in case of IPO's and corporate events publicly available information? (answer the following question with the help of given information)
explanation:
Initial Public Offerings (IPOs) During the past 20 years, a number of closely held companies
have gone public by selling some of their common stock. Because of uncertainty about the appropriate
offering price and the risk involved in underwriting such issues, it has been hypothesized
that the underwriters would tend to underprice these new issues.
Given this general expectation of underpricing, the studies in this area have generally considered
three sets of questions: (1) How great is the underpricing on average? Does the underpricing
vary over time? If so, why? (2) What factors cause different amounts of underpricing
for alternative issues? (3) How fast does the market adjust the price for the underpricing?
The answer to the first question is an average underpricing of about 17 percent, but it
varies over time as shown by the results in Exhibit 6.2 for the total period 1980-2010 and for
various subperiods. The major variables that cause differential underpricing seem to be various
risk measures, the size of the firm, the prestige of the underwriter, and the status of the firm's
accounting firm. On the question of direct interest to the EMH, results in Miller and Reilly
(1987) and Ibbotson, Sindelar, and Ritter (1994) indicate that the price adjustment to the underpricing
takes place within one day after the offering. Therefore, it appears that some underpricing
occurs based on the original offering price, but the ones who benefit from this
underpricing are basically the investors who receive allocations of the original issue. More specifically,
institutional investors captured most (70 percent) of the short-term profits. This rapid
adjustment of the initial underpricing would support the semistrong EMH. Finally, studies by
Ritter (1991); Carter, Dark, and Singh (1998); and Loughran and Ritter (1995) that examined
the long-run returns on IPOs indicate that investors who acquire the stock after the initial
adjustment do not experience positive long-run abnormal returns.
Corporate Events Corporate finance events such as mergers and acquisitions, spin-offs, reorganization,
and various security offerings (common stock, straight bonds, convertible bonds)
have been examined, relative to two general questions: (1) What is the market impact of these
alternative events? (2) How fast does the market adjust the security prices?
Regarding the reaction to corporate events, the answer is very consistentstock prices react
as one would expect based on the underlying economic impact of the action. For example, the
reaction to mergers is that the stock of the firm being acquired increases in line with the premium
offered by the acquiring firm, whereas the stock of the acquiring firm typically declines
because of the concern that they overpaid for the firm. On the question of speed of reaction,
the evidence indicates fairly rapid adjustmentthat is, the adjustment period declines as
shorter interval data are analyzed (using daily data, most studies find that the price adjustment
is completed in about three days). Studies related to financing decisions are reviewed by Smith
(1986). Studies on corporate control that consider mergers and reorganizations are reviewed
by Jensen and Warner (1988). Numerous corporate spin-offs have generated interesting stock
performance as shown by Desai and Jain (1999) and Chemmanur and Yan (2004).