All Events Induce Variance: Analyzing Abnormal Returns When Effects Vary Across Firms
50 Pages Posted: 11 Jan 2006
There are 2 versions of this paper
All Events Induce Variance: Analyzing Abnormal Returns When Effects Vary Across Firms
Abstract
We demonstrate analytically that cross-sectional variation in the effects of events, i.e., in true abnormal returns, necessarily produces "event-induced" variance increases, biasing popular tests for mean abnormal returns in short-horizon event studies. We show that unexplained cross-sectional variation in true abnormal returns plausibly produces non-proportional heteroskedasticity in cross-sectional regressions, biasing coefficient standard errors for both ordinary least squares and weighted least squares. Simulations highlight the resulting biases, the necessity of using tests robust to cross-sectional variation, and the power of robust tests, including regression-based tests for non-zero mean abnormal returns, which may increase power by conditioning on relevant explanatory variables.
Keywords: abnormal returns, event-induced variance, event study methodology, heteroskedasticity
JEL Classification: G10, G14
Suggested Citation: Suggested Citation
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