In
finance
Finance refers to monetary resources and to the study and Academic discipline, discipline of money, currency, assets and Liability (financial accounting), liabilities. As a subject of study, is a field of Business administration, Business Admin ...
, an abnormal return is the difference between the actual
return of a
security and the
expected return. Abnormal returns are sometimes triggered by "events." Events can include
merger
Mergers and acquisitions (M&A) are business transactions in which the ownership of a company, business organization, or one of their operating units is transferred to or consolidated with another entity. They may happen through direct absorpt ...
s,
dividend
A dividend is a distribution of profits by a corporation to its shareholders, after which the stock exchange decreases the price of the stock by the dividend to remove volatility. The market has no control over the stock price on open on the ex ...
announcements, company earning announcements, interest rate increases,
lawsuit
A lawsuit is a proceeding by one or more parties (the plaintiff or claimant) against one or more parties (the defendant) in a civil court of law. The archaic term "suit in law" is found in only a small number of laws still in effect today ...
s, etc. all of which can contribute to an abnormal return. Events in finance can typically be classified as information or occurrences that have not already been priced by the
market.
Stock market
In
stock market
A stock market, equity market, or share market is the aggregation of buyers and sellers of stocks (also called shares), which represent ownership claims on businesses; these may include ''securities'' listed on a public stock exchange a ...
trading, abnormal returns are the differences between a single stock or portfolio's performance and the expected return over a set period of time. Usually a broad index, such as the
S&P 500
The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 leading companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices and in ...
or a national index like the
Nikkei 225
The Nikkei 225, or , more commonly called the ''Nikkei'' or the ''Nikkei index'' (), is a stock market index for the Tokyo Stock Exchange (TSE). It is a price-weighted index, operating in the Japanese yen, Japanese Yen (JP¥), and its compone ...
, is used as a benchmark to determine the expected return. For example, if a stock increased by 5% because of some news that affected the stock price, but the average market only increased by 3% and the stock has a
beta
Beta (, ; uppercase , lowercase , or cursive ; or ) is the second letter of the Greek alphabet. In the system of Greek numerals, it has a value of 2. In Ancient Greek, beta represented the voiced bilabial plosive . In Modern Greek, it represe ...
of 1, then the abnormal return was 2% (5% - 3% = 2%). If the market average performs better (after adjusting for beta) than the individual stock, then the abnormal return will be negative.
:
Calculation
The calculation formula for the abnormal returns is as follows:
where:
AR
it - abnormal return for firm i on day t
R
it - actual return for firm i on day t
E(R
it) – expected return for firm i on day t
A common practice is to standardise the abnormal returns with the use of the following formula:
where:
SAR
it - standardised abnormal returns
SD
it – standard deviation of the abnormal returns
The SD
it is calculated with the use of the following formula:
where:
S
i2 – the residual variance for firm i,
R
mt – the return on the stock market index on day t,
R
m – the average return from the market portfolio in the estimation period,
T – the numbers of days in the estimation period.
Cumulative abnormal return
Cumulative abnormal return, or CAR, is the sum of all abnormal returns. Cumulative Abnormal Returns are usually calculated over small windows, often only days. This is because evidence has shown that compounding daily abnormal returns can create bias in the results.
See also
*
Market value
*
Rate of return
In finance, return is a profit on an investment. It comprises any change in value of the investment, and/or cash flows (or securities, or other investments) which the investor receives from that investment over a specified time period, such as i ...
References
{{DEFAULTSORT:Abnormal Return
Equity securities
Stock market