Allocations, adverse selection, and cascades in IPOs: Evidence from the Tel Aviv stock exchange

We examine theories of IPO underpricing using unique data from Israel where the allocation to subscribers is by equal proration. This enables us to simulate the return earned by uninformed investors. Consistent with Rock's (1986) theory of adverse selection, allocations were negatively related to underpricing. But uninformed investors earned a negative allocation-weighted initial return, although the average initial return was 12%. They could break even, however, by using publicly available information. The data also supports Welch's (1992) theory of information cascades: demand is either extremely high or there is undersubscription, with very few cases in between.