On Event Studies

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On Event Studies
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Random Walk and the EMH

• Random Walk - stock price changes are random
• (Actually submartingale)
• Expected price is positive over time
• Positive trend and random about the trend

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Random Walk with Positive Trend
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Random Price Changes

• Why are price changes random?
• Prices react to information
• Flow of information is random
• Therefore, price changes are random

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Empirical Tests of Market Efficiency

• Event studies is one test of market efficiency
• How Tests Are Structured
• Examine prices and returns over time

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Returns Over Time
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How Tests Are Structured (contd)

• 2. Returns are adjusted to determine if they are
  abnormal
• Market Model approach
• a. Rt at btRmt et
• (Expected Return)
• b. Excess Return (Actual - Expected)
• et Actual - (at btRmt)

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How Tests Are Structured (contd)

• 2. Returns are adjusted to determine if they are
  abnormal
• Market Model approach
• c. Cumulate the excess returns over time

0
t
-t
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Issues in Examining the Results

• Magnitude Issue
• Selection Bias Issue
• Lucky Event Issue
• Possible Model Misspecification