1. Announcement Date of an Event at 0
Event StudY
Basics in Finance
How quickly does the market react to new information? +t -t
Announcement Date of an Event at 0

2. Event study analysis
Measure both the speed and magnitude of market reaction to a certain event
High-frequency (usually, daily) data
Ease of use, flexibility
Experimental design
Pure impact of a given event
Try not to permit “other events” from contaminating study
Collect a sample of similar events and line them all up on the event date

3. Reaction to the unexpected good event

4. Example: How do markets react to corporate financing announcements?
Studies show the following announcements are taken to be “good news” causing stock prices to rise, on average:
Dividend initiations and increases and share repurchases
Leverage increasing transactions (i.e., debt-for- equity swaps)
Acquisitions paid for with cash, spin-offs & divestitures
Some new debt offerings--especially bank loan renewals
Control-concentrating events (new blockholders are announced)

5. The following announcements received as “bad news”
Dividend cuts or suspensions (catastrophic news)
Adoption/proposal of anti- takeover defenses
Any type of equity financing (including convertibles)
Merger financed with new stock issue
Any focus-decreasing transactions (diversification strategies)

6. Methodology: find event to be studied and its announcement date
Type of the event
Share repurchase or dividend change or announcement of a M&A
Date of the event τ=0
Announcement, not the actual payment
The event window: several days around the event date
Selection of the sample
Must be representative
No selection biases

7. Modelling the return generating process
Abnormal return: ARi,t = Ri,t – E[Ri,t]
Normal return: expected if no event happened
Often the market model: Ri,t = αi + βiRM,t + εi,t,
The estimation window: period prior to the event window
Usually: 250 days or 60 months
Event window ( for example: -2 days to +5 days)
Aggregating the results over time:
Cumulative abnormal return (CAR):
CAR[τ-t1: τ+t2] = Σt=τ-t1: τ+t2 ARi,t
Find if CARs are Positive, Negative, or Zero.

8. Strengths of the event study analysis
Direct and powerful test of efficiency
Shows whether new info is fully and instantaneously incorporated in stock prices
Test corporate finance theories
Average AR measures market reaction to different types of the events
EXAMPLE: Fama Fisher Jensen & Roll tests of stock splits
In theory, nothing happens in a stock split
Found that those with splits and higher dividends gained, those with no dividend increases stayed flat.
Fama, Eugene F., Lawrence Fisher, Michael Jensen and Richard Roll (1969).
The adjustment of stock prices to new information, International Economic Review, 10 (1), 1-21.

9. Stock Splits
Eugene Fama, Lawrence Fischer, Michael Jensen, and Richard Roll, 1969, The adjustment of stock prices to new information, International Economic Review 10, 1-22.
Abstract: There has been very little actual testing of the speed of adjustment of prices to specific kinds of new information. The prime concern of this paper is to examine the process by which common stock prices adjust to the information (if any) that is implicit in a stock split. In doing so we propose a new event study methodology for measuring the effects of actions and events on security prices.
We would expect NO REACTION.

10. The First Event Study--Stock Splits
Average stock price response to the “event” of a stock split. The stock prices are lined up in “event time,” where the month of the stock split is t=0. Because all of the information in the stock split is incorporated into stock prices by the event date, there is on average no tendency for prices to change after the split.

11. FFJR Findings In a 2/1 stock splits, on average the price drops 50%
In a 3/1 stock split, on average the price drops 33%
FFJR find that firms that both raise their dividend and have a stock split do show an increase in value.
They find that firms that cut their dividend and have a stock split decline in value

12. Product Recall Events
An event study on drug recall announcements or auto recall announcements find negative returns to the drug company or auto company.
But even other firms in the industry have negative cumulative abnormal returns.
Salience – impact reminds shareholders of recall risks.
Lumped Together – customers think all firms are recalled.
Marcus, R.D., Swidler, S., and Zivney, T.L., "An Explanation of Why Shareholders' Losses are So Large After Product Recalls," Managerial and Decision Economics, Vol. 8, No. 4, 1987,

13. Werner DeBondt & Richard Thaler Journal of Finance (1985)
"Does the stock market overreact?"
Test the overreaction hypothesis:
Investors pay too much attention to current earnings and punish companies with low P/E ratios
Later earnings and prices return to fundamental levels
Find that long-term losers (stocks that perform poorly over the prior five-year period) perform better than winners over the subsequent five-year period.
Examine long-run performance of winner & loser portfolios formed on the basis of past returns
Over different formation and testing periods

14. Overreaction to Good and Bad News
GOOD NEWS
BAD NEWS

15. Data and methodology CARi = S (ARi )
Monthly returns of NYSE common stocks in (CRSP)
Stocks with at least 85 months of data (to exclude small and young firms)
Market index:
Equal-weighted average return on all CRSP stocks
Market-adjusted approach for abnormal returns, AR:
ARi = Ri – RM
Similar results for CAPM and market model approaches and find the Cumulative AR’s.
CARi = S (ARi )

16. Test procedure Consider 16 non-overlapping 3 year periods:
1/ /1932, …, 1/ /1980
In the beginning of each period, t=0:
Rank all stocks on cumulative excess returns during the formation period (past 36 months)
Top 35 / top 50 / top deciles stocks = winner portfolio
Similarly, for loser portfolio
Compute ARs and CARs for the next 36 months: t=1:36
Tested hypotheses: ARL=0, ARW=0, ACARL=ACARW
Finding:
Losers outperform winners by 24.6% during 36 month testing period
Mostly driven by
Losers that outperform the market by 19.6%

17. Potential Returns From An Overreaction Strategy
LOSER PORFOLIO
WINNER PORTFOLIO

18. Discuss Ways to Test Market’s Reactions to the following
Announcements of Stock Buybacks
Announcements of Accounting Irregularities
Search news articles
How would we test the impact?
Search news articles
How would we test the impact?