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2 Event Studies
Motivation
Basic methodology
Bells and whistles
Outline
2 Event Studies
Motivation
Basic methodology
Bells and whistles
E[rt+1 r0 ] = 0
Econometric approaches
The aim of this first part of the lecture is to survey and put into
perspective these econometric approaches.
Outline
2 Event Studies
Motivation
Basic methodology
Bells and whistles
With the factor risk premium fixed, the model implies that the
intercepts of the following time-series regressions must be zero
e
ri,t+1 r0 ri,t+1 = i + i ft+1 + i,t+1
e
so that E[ri,t+1 ] = i .
])1
0 (Var[ 2N .
To evaluate Var[
] requires further distributions assumptions
which implies !2
1 T [ft+1 ]
E
Var[
] = 1+ .
T
T [ft+1 ]
T [r e ] 2
! !2
E T [r e
E ]
q,t+1 m,t+1
e e
(T N 1)
[r
T q,t+1 ]
T m,t+1 ]
[r
,
N
! 2
T [r e
E ]
m,t+1
1+
e
T [rm,t+1 ]
Outline
2 Event Studies
Motivation
Basic methodology
Bells and whistles
Cross-sectional regressions
When the factor is not an excess return that itself must be priced
by the model, the model does not imply zero time-series intercepts.
OLS estimates
The cross-sectional OLS estimates are
= (0 )
1 (r e )
i
e
= r .
i
Var[
]1
2N1
with
1 0 1 I (
Var[] = I ( 0 ) 0 )
1 0
T
Two important notes
Var[
] is singular, so Var[ ]1 is a generalized inverse and
the 2 distribution has only N 1 degrees of freedom.
Testing the size of the residuals is bizarre, but here we have
additional information from the time-series regression (in red).
Michael W. Brandt Methods Lectures: Financial Econometrics
Linear Factor Models Cross-sectional approach
GLS estimates
and
1 0 1 1 0
Var[
GLS ] = ( ) .
T
Shanken (1992)
The generated regressor problem, the fact that is estimated in
the first stage time-series regression, cannot be ignored.
Corrected estimates are given by
!
1 0 1 I (
0 )
0 )
1 0 2
OLS ] = I (
Var[ 1+ 2
T f
!
1 2
Var[
GLS ] = ( 0 1 1 0 1 +
)
T f2
In the case of the CAPM, for example, the Shanken correction for
annual data is roughly
T [rmkt,t+1 ] 2
!
0.06 2
E
1+ =1+ = 1.16
T [rmkt,t+1 ] 0.15
e b e
E[rt+1 ]= Cov[rt+1 , ft+1 ]
1 bE[ft+1 ]
e ,f
Cov[rt+1 t+1 ] bVar[ft+1 ]
= .
Var[ft+1 ] 1 bE[ft+1 ]
| {z }| {z }
1 PT i = 1 PT
i = i,t and
t=1 i,t .
T t=1 T
Outline
2 Event Studies
Motivation
Basic methodology
Bells and whistles
Time-series regressions
Cross-sectional regressions
SDF regressions
Outline
2 Event Studies
Motivation
Basic methodology
Bells and whistles
Firm characteristics
So far
H0 : i = 0 i = 1, 2, ..., n
HA : i 6= 0 for some i
H0 : i = 0 i = 1, 2, ..., n
HA : i = 0 xi
rie == i + 0 xi + i .
Portfolios
Stock level time-series regressions are problematic
Way too noisy.
Betas may be time-varying.
Characteristic sorts
Conditional information
In a conditional asset pricing model expectations, factor
exposures, and factor risk premia all have a time-t subscripts
Et [rt+1 r0 ] = t0 t .
t = 0 (t1 0 ) + t .
t = 0 Zt or t = 0 Zt .
Condition down
e e
E Et [(1 (0 + 1 Zt )ft+1 )rt+1 ] = E (1 (0 + 1 Zt )ft+1 )rt+1 = 0.
Outline
2 Event Studies
Motivation
Basic methodology
Bells and whistles
Event studies are popular not only in accounting and finance, but
also in economics and law to examine the role of policy and
regulation or determine damages in legal liability cases.
Outline
2 Event Studies
Motivation
Basic methodology
Bells and whistles
Setup
Reference models
Abnormal returns
Using the market model as reference model, define
i, = ri,
AR i i rm, = T1 + 1, ..., T 2.
AR = 1 PN AR i, .
N i=1
2. Cumulate abnormal returns over the event window
i (T1 , T2 ) = PT2
CAR
=T1 +1 AR i,
or PT2
CAR(T1 , T2 ) =
=T1 +1 AR .
Hypothesis testing
Basic hypothesis testing requires expressions for the variance of
i (T1 , T2 ), and CAR(T
, CAR
AR 1 , T2 ).
= 1 PN 2
Var AR
N 2 i=1 i
PT2
Var CAR(T 1 , T2 ) = =T1 +1 Var AR .
Example
Earnings announcements
Outline
2 Event Studies
Motivation
Basic methodology
Bells and whistles
Dependence
Heteroskedasticity