Event studies

TFGDA10
Miguel de Jesús
 What is an event study?
An event study is a statistical method used to answer the question
“What is the effect of an economic event on the value of a firm?”

These events can be firm-specific, e.g.,

▶ Announcement of mergers and acquisitions
▶ Earnings announcements
▶ Announcement of new debt or equity issues
▶ Announcement that the firm is in litigation
Or market-wide, e.g.,
▶ Announcement of macroeconomic variables
▶ Announcement of lockdowns or COVID deaths
▶ Catastrophic events

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 What is an event study?
Assuming that markets are efficient, the impact of an event will be
reflected immediately in asset prices.

Example: Effect of an earnings announcement on firm value

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 What is an event study?
Assuming that markets are efficient, the impact of an event will be
reflected immediately in asset prices.

Example: Effect of the merger of competitors on firm value

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 Outline of an event study
The event study methodology entails the following steps:
1. Definition of event
2. Selection criteria
3. Estimation of normal returns
4. Computation of cumulative abnormal returns
5. Significance testing of cumulative abnormal returns

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 Outline of an event study
Step 1: Definition of event
▶ What is the event of interest?
▶ How many days before and after the event will stock prices be
examined (the event window )?
▶ In the first example, the event window is from 21 days before to
21 days after the earnings announcement
▶ Days before the event are included to determine whether the
market acquires information before the actual announcement
▶ Days after the event are considered since markets can react
slowly to the announcement

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 Outline of an event study
Step 2: Selection criteria
▶ Which stocks will be included in the study? For example, one
can restrict the study to
▶ All stocks in the Madrid Stock Exchange
▶ Pharmaceutical or technological firms only

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 Outline of an event study
Step 3: Estimation of normal returns
▶ To evaluate the event’s impact, we need a measure of abnormal
or “unexpected” return
▶ Abnormal return is the actual return of the stock minus the
normal return of the stock
▶ Normal return is the counterfactual return that would be
expected if the event did not take place
▶ For our purposes, the normal return of stock is the return
implied by the CAPM model
▶ Stock returns change only because market returns change
▶ The excess return of a stock is equal to the excess market return
multiplied by its beta

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 Outline of an event study
Step 3: Estimation of normal returns
For stock i on day d within the event window,

Abnormal returni,d = Actual excess returni,d − Normal excess returni,d

Normal excess returni,d = βi × (Market returnd − Risk-free rated )

▶ βi is estimated by a linear regression during the days before the

event window (the estimation window )
▶ Estimation windows usually are 60, 90, 120, 180, or 360 days

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 Outline of an event study
Step 3: Estimation of normal returns
For stock i on day d within the event window,

Abnormal returni,d = Actual excess returni,d − Normal excess returni,d

Normal excess returni,d = βi × (Market returnd − Risk-free rated )

▶ Market return is the daily return of the market index (S&P 500
or NYSE Composite for US, IBEX 35 for Spain)
▶ Risk-free rate is the yield on government bonds (1-month
Treasury bill for US, EURIBOR for Spain)

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 Outline of an event study
Step 4: Computation of cumulative abnormal returns
For each stock i, ARi,d
▶ Unexpected return d days from the event
▶ If event affects firm value, the magnitude of ARi,0 must be high
▶ If event is not anticipated, AR must be zero before the event
▶ If markets incorporate new information right away, AR must be
zero after the event

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 Outline of an event study
Step 4: Computation of cumulative abnormal returns
For each day in the event window [T1 , T2 ], we next calculate the
cumulative abnormal return
d
X
CARi,d = ARi,t = ARi,T1 + ARi,T1 +1 + ... + ARi,d−1 + ARi,d .
t=T1

▶ Total change in price from start of the event window until day d
▶ If event is not anticipated, CARi,−1 must be zero
▶ If event affects firm value, CARi,0 must not be equal to zero
▶ If markets incorporate information right away, CARi,d must be
same as CARi,0 for d > 0

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 Outline of an event study
Step 5: Significance testing of cumulative abnormal returns
Our estimate of the impact of the event on firm value d days from
the event is the average of the CARs across all N firms:
N
1 X
ACARd = CARi,d
N
i=1

Suppose we find that ACAR0 is 2%. Can we confidently say that the
event has a positive effect on firm value?
▶ No, we have to take into account that this 2% is an estimate
and, hence, not error-free
▶ Most of the CARs could be negative, but a few positive values
could be pulling the average towards 2%
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 Outline of an event study
Step 5: Significance testing of cumulative abnormal returns
We create a 95% confidence interval centered around this estimate.
▶ If the confidence interval we obtain is (1%, 3%), this means that
we can be 95% confident that the true impact of the event is
between 1% and 3%. So, we can be confident that the effect of
the event on market value is positive.
▶ If the confidence interval we obtain is (−1%, 5%), we cannot be
confident that the effect is positive or negative. We do not
accept our hypothesis that the event affects firm value.

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 Outline of an event study
Step 5: Significance testing of cumulative abnormal returns
A 95% confidence interval for the impact of the event on firm value
d days from the event is:
 
1 1
ACARd − 1.96 √ SCARd , ACARd + 1.96 √ SCARd
N N
.
SCARd is the standard deviation of the CARs:
v
u
u 1 X N
SCARd = t (CARi,d − ACARd )2 .
N −1
i=1

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 Example of an event study
Step 1: Definition of event
▶ Event: Earnings announcement
▶ Event window: 10 days before to 20 days after

Step 2: Selection criteria

▶ All stocks that announce very high or very low EPS
▶ Time period is from January 1, 2016 to December 31, 2016
▶ 578 announcements with very low EPS (387 stocks), 654
announcements with very high EPS (440 stocks)

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 Example of an event study
Steps 3-5: See Excel file.
▶ Estimation window is 60 days

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 Example of an event study
Results: High EPS
.06
.04
CAR
.020
−.02

−10 0 10 20
Days from earnings announcement

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 Example of an event study
Results: Low EPS
.02
0
−.02
CAR
−.04
−.06

−10 0 10 20
Days from earnings announcement

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 Outline of TFG
Section I: Table of contents
Section II: Introduction → Short summary of Sections III and IV
Section III: Hypotheses
▶ Description of event
▶ Relevance of study → Why is the event important to study?
▶ Hypotheses → What do we expect the effect to be?
▶ Related literature → 5 ACADEMIC studies asking a similar
question
Section IV: Empirical results
▶ Data sources
▶ Discussion of event study methodology → Explain the steps in
your own words
▶ Results and relation to hypotheses
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 Outline of TFG
Section V: Conclusion
Section VI: Bibliography
Section VII: Appendix

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 Important dates

1. December 20, 2024 (23:59, Canvas): Draft of TFG for final

revision
2. January 8, 2024 (23:59, Canvas): Final TFG
3. January 15, 2024 to January 19, 2024: TFG Defense

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