Lec 7 - Mesuring abnormal return in short term

Question 1

What do the following factors mean?

Answer 1

rit = total return in test period
E(rit) = expected return
ARit = abnormal return on a day

Question 2

What is Rit made up of?

Answer 2

Return due to impact of the event of interest
Return due to common factors (expected return)

Question 3

What is E(rit)?

Answer 3

Return if the event hadn’t happened (return due to common factors)

Question 4

What is AR(it)?

Answer 4

Return due to the event in question

Question 5

What aspect causes models to differ?

Answer 5

The estimation of expected return

Question 6

What causes the measurement of AR to differ?

Answer 6

Horizon of test period (long vs short term)
The model used to estimate E(r)

Question 7

In the market model, what is expected return?

Answer 7

Alpha hat + beta hat - which are estimated in the estimation period that we specify

Question 8

What is the cumulative abnormal return?

Answer 8

When you have multiple days in the test period (I.e 2 days before and after the event day)
When you have the single day abnormal returns, you add them all up and get the cumulative abnormal returns
You get “CAR” which is all of it together

Question 9

What if there is a large sample?

Answer 9

Use Average Abnormal Return (AARt) and Cumulative Average Abnormal Return (CAAR)
Find average across all firms for a single day

Question 10

AArt formula:

Answer 10

Question 11

CAARt formula:

Answer 11

Question 12

What is CAPM (formula included)?

Answer 12

Capital Asset Pricing model
- Similar to market model, with its difference being CAPM works with observed returns without any adjustments

Question 13

What is Fama French 3 Factor Model?

Answer 13

Under this - expected return is the risk free rate + the alpha estimates + the beta estimates * excessive market return + factor returns * the coefficients (gamma estimates * value factor returns) (delta coefficient * size factor returns) which gives = the expected returns
Then expected return - actual return = abnormal return under fama french 3 factor model

Question 14

How can the T-statistic for CAR, AAR and CAAR be further calculated?

Answer 14

By building on the t-statistic for the single-day firm abnormal return
The t-statistic in principle is calculated as the abnormal return scaled by its standard error

Question 15

What is standard error in the context of t-statistics?

Answer 15

The standard deviation of the abnormal return

Question 16

How do we calculate standard error?

Answer 16

Using Patell’s Z-statistic (Vit):