When the underwriter is the market maker: An examination of trading in theIPO aftermarket

This paper examines aftermarket trading of underwriters and unaffiliated ma rket makers in the three-month period after an IPO. We find that the lead u nderwriter is always the dominant market maker; he takes substantial invent ory positions in the aftermarket trading, and co-managers play a negligible role in aftermarket trading. The lead underwriter engages in stabilization activity for less successful IPOs, and uses the overallotment option to re duce his inventory risk. Compensation to the underwriter arises primarily f rom fees, but aftermarket trading does generate positive profits, which are positively related to the degree of underpricing.