We investigate the relationship between IPO long-run underperformance (Ritter, 1991; Loughran and Ritter, 1995) and the idiosyncratic risk puzzle (Ang, Hodrick, Xing, and Zhang, 2006) or the phenomenon of abnormally low returns for stocks with high idiosyncratic risk. We find that IPO long-run underperformance is a manifestation of surprisingly low returns for high idiosyncratic risk stocks. IPO underperformance disappears after we control for idiosyncratic risk. On the other hand, we find that the idiosyncratic risk puzzle is magnified by IPO underperformance. Our results are robust to various specifications or sample requirements. We evaluate a couple of potential common causes for the two puzzles and conclude that investors’ preferences for stocks with lottery features is the primary mechanism linking the two puzzles.

We extend the IPO literature analysing the role of financial market integration in the development of IPO markets and the pricing of newly listed stocks. Using a hierarchical linear model, we show that differences in underpricing between markets with high and low financial integration levels are economically significant and may explain the choice of location in the listing process. Firstly, market integration negatively affects the level of IPO underpricing by increasing the importance and efficiency of the financial intermediation process via tradable securities. Secondly, the presence of a deeper market integration has a moderation effect, which weakens the explanatory power of country institutions in the cross-country variation of IPO underpricing. Finally, we suggest a hierarchical structure be assumed for the modelling of cross-country IPO studies with heterogeneous country characteristics. Our results are robust to alternative measures of financial integration and several model specifications.

We examine the role of bank capital in moderating the relationship between bank liquidity creation and the failure risk in U.S. banks over the period of 2003–2014. We find that, conditional on bank capital, bank liquidity creation is related to bank failure risk negatively. The negative relationship is moderated positively (i.e., strengthened) by (changes in) bank capital. This finding is consistent with the view that banks may strengthen their solvency through increased capital in response to the illiquidity risk associated with liquidity creation; and higher capital enhances the ability of banks to create liquidity. The result is robust to different estimation methods, and alternative measures of liquidity creation, bank failure risk, and bank capital. Further analysis shows that the significant and negative effect is more prominent for small banks, and the impact of bank capital was more pronounced during the recent financial crisis of 2007–2009.