An event study is used to determine whether the financial markets have a statistically relevant reaction to a past corporate event or the announcement of a future event.
An event study is a research methodology used to determine whether financial markets have a statistically significant reaction, that is, has positively or negatively affected a company’s stock prices, to a past corporate event or the announcement of a future event. It is classified as a type of econometrics, or economic measurement, that uses a combination of mathematical and statistical economics and economic theory. The underlying assumption of an event study is that the magnitude of change in performance around a specific event can provide a measure that can predict the effect on shareholder value during similar events at other companies.
The event that affects the value of a company’s shares may be within the control of the company, such as the announcement of a merger, or outside the control of the company, such as the approval of a regulatory act by the government that will have a negative impact on the company’s future company operations. A typical event study would look at the stock price reaction to the same type of event, such as the issuance of a stock option, experienced by multiple companies. The actual issue date of the option would differ between companies, but would default to the “time of event”, where an event horizon would be established and stock prices would be analyzed during the event time window.
The reliability of an event study generally depends on the length of the event horizon used in the study. Common research theory in this area holds that short-term event studies are more reliable than long-term event studies, in which the study cannot control for market effects over long periods of time. There is an efficient market hypothesis which says that if information is going to affect a stock price, it will do so immediately, so the longer the study window, the less likely it is that volatility in stock prices may be directly attributable to the dissemination of information.
There is a basic three-step format for an event study. First, choose an event that has occurred across multiple companies and set a time period before and after the event to serve as the event window. Then review changes in stock prices and any changes in the companies’ market index during the event window. Finally, perform statistical analysis to see if price changes are abnormally large or small compared to typical returns for these companies and controlling for market effects and outside influences.