Course 2 Event studies.pdf

7/31/2019 Course 2 Event studies.pdf

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What is an event study?

An event study measures the impact of aspecific event on the value of a firm (MacKinlay,

1997);

Event studies examine the behavior of firmsstock prices around corporate events (Kothari

and Warner, 2007).

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Overview of Event Studies

Event studies examine the effect of some eventor set of events on the value of assets

Loosely speaking, a t-test of the change in price ofsome asset

Unexpectedly large increase or decrease - relativeto standard deviation of typical change

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Overview of Event Studies (2)

Value of assets Firms stock prices are the most common Exchange rates Bond prices

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Overview of Event Studies (3)An event study is an attempt to determine whether a

particular event in the capital market or in the life of acompany has affected a companys stock market performance.

The event-study methodology aims to separate company-specific events from market- and industry specific events, andhas often been used as evidence for or against marketefficiency.

An event study aims to determine whether an event orannouncement caused an abnormal movement in acompanys stock price.

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Examples of events or set of events

mergers and acquisitions announcements, takeovers, earnings announcements, stock splits, issues of new debt or equity, resignation of CEO or deaths of corporate

executives, product recalls

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Examples of events or set of events

announcements of macroeconomic variables(inflation rate, GDP growth, trade deficit etc.),

natural disaster (earthquake, flood or fire) regulatory change, change in state of corporation etc.

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Impact of an event on

global financial markets, national financial markets, equity or debt markets, one sector, one company.

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Impact of an event on

value of assets, return variance, trading volume, operating performance, total revenue etc.

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Stages of an event study

1. defining the event and the event window;

2. measuring the stocks performance during theannouncement period;

3. estimating the expected performance of the stockduring this announcement period in the absence ofthe announcement;

4. computing the abnormal return and measuring itsstatistical and economic significance.

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First stage

Defining the event under investigation; Determining the selection criteria for the

inclusion of a given firm(s) in the study; Identify the period over which the security prices

of the firms involved in this event will beexamined (prior and post- event)

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Type of event

Are we able able to anticipate the event? No


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Are we able to anticipate the event?YES


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Second stage

measuring the stocks performance for windowperiod;

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Ri, t+ n =pi, t+ n pi, t

pi, t

Ri, t+ n = ln( pi, t+ n

pi, t)


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Third stage

Measuring the expected return, the return thatwould have accrued to the shareholders in the

absence of this or any other unusual event Selecting and applying the model of expected

returns

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Expected return models 1 The constant expected returns model:

where, Rit is the return for stock i over time periodt, i is the expected return for stock i, and eit is the

usual statistical error term.

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Rit = i + it


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Expected return models 2 The market model:

where, ai and bi are firm-specific parameters, andRmt is the market return for the period t.

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Ri, t =i + i Rm, t + i, t


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Expected return models 3 Capital Asset Pricing Model (CAPM):

where, Rf is the risk free rate and i is the beta orsystematic risk of stock i.

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Ri, t = Rf + i (Rm, t Rf ) + i, t


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Expected return models 4Arbitrage Pricing Theory:

where, F1, F2,..., Fn are the returns on the n factors

that generate returns, and are the factor

loadings.

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Ri, t =0 +i1F1t +i2F2t + ...+inFnt + i, t


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Fourth stage The unexpected announcement period return, also

known as the abnormal return, is computed as theactual return minus the estimated expected return.

where ARit, Rit, and E(Rit|X) are the abnormal, observed, andpredicted returns respectively for time period t.

This abnormal return is the estimated impact of theevent on the share value.

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ARi, t = Rit E(Rit Xt)


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Measuring statistical and economic significanceof abnormal return

Designing of the testing framework for theabnormal returns; Defining the null hypothesis and and determining

the techniques for aggregating the individual firmabnormal returns

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Type of event Single event


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Multiple events


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Cumulative average abnormal returns (CAR)could be calculated over following different timeintervals [ -1,+1], [ -2,+2], [ -5,+5], [ -10,+10] ..


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Following Brown and Warner (1985) we cancalculate the statistical significance as follows:

where


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References: Stephen Brown, and Jerold Warner, 1980,Measuring Security Price

Performance, Journal of Financial Economics, 8, 205-258.

Corrado, Charles, 1989,A nonparametric test for abnormal security-priceperformance in event studies, Journal of Financial Economics, Vol. 23, No.2, pp. 385-395.

Craig MacKinlay, 1997, Event Studies in Economics and Finance, Journal ofEconomic Literature, 35, 13-39.

Charles Corrado, 2011, Event studies: A methodology review. Accounting &Finance, 51: 207234.

S.P. Khotari, and Jerold Warner, 2006,Econometrics of Event Studies, inEspen Eckbo (ed.), Handbook of Corporate Finance: Empirical CorporateFinance, Volume A (Handbooks in Finance Series, Elsevier/North-Holland)

Benninga, Simon, 2008,Financial modeling, 3rd ed., The MIT Press

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Take-home

One page with one (or more) potential researchideas based on the event study methodology.

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Documents

Course 2 Event studies.pdf