Event study helps to determine the effect of an event on a dependent variable. In most cases event study is used to determine the impact of an event on the stock prices of a company. The main motive of the event study is to find whether the event has abnormal returns on the prices of the stock. In other words whether the prices would have changed if the event has not taken place. To conduct the event study following steps can be followed:
Step 1: Selection of event
For any event study, selection of the event is the first and most important thing. Researcher can choose event such as:
- the merger and acquisition,
- announcement of dividend,
- retirement of the chairman or,
- any other event associated with the company which is selected for the study.
It is important to note that the event should have particular announcement date.
Step 2: Selection of event window for event study
After the selection of the event and the announcement date of the event the next is to select the event window. The event window is the time period for which the expected return and the abnormal return will be calculated. For example if when selected the merger and acquisition of a company with the event and the date of official announcement on 15th January. We can select the event window 30 days before 30 days after 15th January or 60 days before and after the announcement date. The event window will vary according to the selection of window. There is not any particular formula for selection of event window however minimum of 20 days before and after the announcement date can give some useful information.
Step 3: Calculation of the return
The return on the share prices of the company is selected for the study and the market return in which the shares of the selected companies are traded.
Return on share price of selected company
Since we want to see the impact of some particular event on the share prices of the particular company, the next step is to calculate the return on the share prices. One can use the following formula to calculate the return on share prices :
Rit is the return of company “i” in time period “t”, Pit is the closing share price in time period t and P t-1 is the closing share price in time period “t-1″.
To calculate the expected return the data for the market return is necessary. The market return for the study will depend on the company selected for the study.
For example while chosing the companies from Nifty 50, the return on Nifty Fifty index is chosen.
Formula for the market return is similar to formula of return on share prices. The only difference will be that instead of the closing share price, closing price of the index is chosen.
Step 4: Calculation of the expected return
Event study helps to examine a significant difference between the expected return of the share prices and the actual return of the share prices. Calculation of actual return is shown in (step 3). Expected return of the share price can be calculated by regression with the following equation:
E(Rit) is the expected return on share price.
Rmt is market return at the time period t.
Expected return can be calculated in Microsoft Excel with the following formula:
Expected Return = intercept + (slope * market return)
- Slope:- slope (return of company, return of market)
- Intercept:- intercept ( return of company, return of market)
Step 5: Calculation of Abnormal Return
The abnormal return is the difference between the actual return and the market return. It is calculated as:
Abnormal Return = Actual Return – Expected Return
Step 6: Average Abnormal return
To calculate average daily abnormal return for the study period (event window) by calculating arithmetic mean of the abnormal return.
ARit is abnormal return of firm ‘i” at time period “t”.
Step 7: Cumulative average abnormal return
The cumulative average abnormal return for the study period is calculated as follows:
AARit is average abnormal return of firm “i” at time period “t”.
Step 8: Conducting the t- test
The last and the final step of the event study is to test whether the event leads to abnormal return in the share prices or not using t- test.
t- test is performed as follows:
AAR/ standard error (Source : Khotari & Warner, 2006)
Where standard error is calculated in Excel using the following formula;
Standard Error = STEYX (return on company share, return on market)
Now, if the average abnormal return is significantly different from 0, then we can conclude that the event has significant impact in the share prices of the company which leads to abnormal return. On the other hand if the average abnormal return is not significantly different from 0 then the event do not have significant impact on share prices of the company.
- Khotari, S. P., & Warner, J. B. (2006). Econometrics of Event Studies (No. Volume A). New Hampshire. Retrieved from http://www.bu.edu/econ/files/2011/01/KothariWarner2.pdf.