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Econometrics for Finance

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 ?.

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Econometrics for Finance

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  1. Econometrics forFinance Session 1: Event Study Dr.Arnat Leemakdej

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

  3. 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.

  4. 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.

  5. 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

  6. 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 0 T2 T3

  7. 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.

  8. 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=

  9. 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:

  10. A pictorial depiction! • Time • Firms

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

  12. 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

  13. 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”?

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