Econometrics for Finance Session 1: Event Study Dr.Arnat Leemakdej

Outline of Session Overview of Event Study Methodology. FFJR (1969) Event Study Design Assignment#1

What is an Event Study ? An “event” is the public announcement of a (usually voluntary) corporate action, such as a merger, a security issue, an earnings announcement, a new investment announcement, a stock split, a new product launch etc. An “event study” is an econometric procedure for isolating the stock price impact of the event or its impact on firm value. Seminal papers: Fama et al.(69), Brown and Warner (1980, 85) Excellent Review Papers: MacKinlay, Journal of Economic Literature,1997.

Seven Steps to an Event Study Event Definition Define the event of interest and the period over which the impact on security prices will be examined -the ‘event window’. Firm Selection Criteria availability of data, characteristics of the data sample. Measuring Normal and Abnormal Returns Actual return minus normal return (estimated return as if the event had not occurred). Estimation Procedure Estimate model parameters over the estimation period, usually prior to the event. Testing Procedures Define Null Hypothesis, aggregation of the AR’s, statistical tests. Empirical Results Diagnostics, sample size and any possible violations of assumptions. Interpretation and Conclusions Economic insights into the event and its impact on firm value, competing explanations etc.

Event Study Methodology- some issues Exactly when did news of the event ‘hit’ the market? (‘at 11:15 am’, ‘today’, ‘this week’, ‘this month)- “event window” The more precise the answer, the more powerful the event study analysis Is the announcement of the event partly anticipated? (rumors, leakage, prediction) The less the event is anticipated, the more powerful the event study analysis Is the event voluntary? (did managers have a choice) Voluntary events convey more of managers’ information about the firm Does this event trigger future events? (merger may trigger antitrust complaint, initial tender offer may trigger competing bid, IPO may trigger SEO) Fewer the triggering events, the easier the interpretation of the results

Event Study Procedure (1) (estimation window] (event window] (post-event window] Returns indexed in event time. Let 0 be event date, event window is T1 +1 to T2, (Length=T2-T1) Estimation window is T0 +1 to T1 (length= L1=T1-T0) Event window is set around the event day 0, e.g. (0,+1), (-1,0,1) since you can then study AR’s around the announcement date. Post-event window is sometimes used as well. T0 T1 T2 T3

Event Study Procedure (2) Abnormal Return is defined as: Common candidate models for the “normal” return are the constant mean return model and the market model: Mean Return model typically uses nominal daily returns but with monthly data nominal and and real returns used. Could use multifactor models (like Fama French three factor model etc.)- but gains are limited.

Event Study Procedure (3) Next, estimate the market model parameters for each firm in the sample during estimation period using a suitable market index. Next, using the estimated parameters of the market model, calculate for each firm period in the event window: H0: Event has no impact, AR jointly normal with mean=0 and variance=

Event Study Procedure (4) Aggregating Abnormal Returns: Calculate the CARs over event window in two ways: Across firms and then over time (t1,t2): Across event window time (t1,t2) and over firms:

A pictorial depiction! Time Firms

FFJR (1969) Original Paper for Event Study Impact of Stock Split The Information Issues Implications on Market Efficiency

Event Study Design What should be the length of Event Window What should be the length of Comparison Period (Estimation Period) How to formulate Portfolio

Assignment#1 Read Brown & Warner (1985) What is the “calendar effect” and how can we avoid it? How to define the “Event Date”? What should be the impact on event study if the market already anticipates the “news”?