All Events Induce Variance: Analyzing Abnormal Returns When Effects Vary Across Firms

50 Pages Posted: 11 Jan 2006

See all articles by Scott E. Harrington

Scott E. Harrington

University of Pennsylvania - Wharton School

David G. Shrider

Miami University of Ohio - Richard T. Farmer School of Business Administration

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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

Harrington, Scott E. and Shrider, David G., All Events Induce Variance: Analyzing Abnormal Returns When Effects Vary Across Firms. Journal of Financial and Quantitative Analysis, Forthcoming, Available at SSRN: https://ssrn.com/abstract=874820

Scott E. Harrington

University of Pennsylvania - Wharton School ( email )

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David G. Shrider (Contact Author)

Miami University of Ohio - Richard T. Farmer School of Business Administration ( email )

Oxford, OH 45056
United States
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513-529-8598 (Fax)

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