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    05 Abnormal Return

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    Gna Ong
    An abnormal return describes unusual profits generated by securities or portfolios over a period compared to expected returns. Abnormal returns are important for determining risk-adjusted performance versus benchmarks and identifying manager skill. A cumulative abnormal return is the total of all abnormal returns over a short window, usually days, and is used to measure the effects of events on stock prices and model accuracy.

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    05 Abnormal Return

    Uploaded by

    Gna Ong
    54 views2 pages
    An abnormal return describes unusual profits generated by securities or portfolios over a period compared to expected returns. Abnormal returns are important for determining risk-adjusted performance versus benchmarks and identifying manager skill. A cumulative abnormal return is the total of all abnormal returns over a short window, usually days, and is used to measure the effects of events on stock prices and model accuracy.

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    An abnormal return describes unusual profits generated by securities or portfolios over a period compared to expected returns. Abnormal returns are important for determining risk-adjusted performance versus benchmarks and identifying manager skill. A cumulative abnormal return is the total of all abnormal returns over a short window, usually days, and is used to measure the effects of events on stock prices and model accuracy.

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    © All Rights Reserved
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    Download as docx, pdf, or txt
    54 views2 pages

    05 Abnormal Return

    Uploaded by

    Gna Ong
    An abnormal return describes unusual profits generated by securities or portfolios over a period compared to expected returns. Abnormal returns are important for determining risk-adjusted performance versus benchmarks and identifying manager skill. A cumulative abnormal return is the total of all abnormal returns over a short window, usually days, and is used to measure the effects of events on stock prices and model accuracy.

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    © All Rights Reserved
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    of 2

    Abnormal Return

    By ADAM BARONE
    Updated Apr 25, 2019

    What Is an Abnormal Return?


    An abnormal return describes the unusual profits generated by given securities or portfolios over a
    specified period. The performance is different from the expected, or anticipated, rate of return (RoR)
    for the investment. The anticipated rate of return is the estimated return based on an asset pricing
    model, using a long run historical average or multiple valuations.

    Why Abnormal Returns Are Important


    Abnormal returns are essential in determining a security's or portfolio's risk-adjusted performance
    when compared to the overall market or a benchmark index. Abnormal returns could help to identify a
    portfolio manager's skill on a risk-adjusted basis. It will also illustrate whether investors received
    adequate compensation for the amount of investment risk assumed.

    An abnormal return can be either positive or negative. The figure is merely a summary of how the
    actual returns differ from the predicted yield. For example, earning 30% in a mutual fund which is
    expected to average 10% per year would create a positive abnormal return of 20%. If, on the other
    hand, in this same example, the actual return was 5%, this would generate a negative abnormal return
    of 5%.

    Cumulative Abnormal Return


    Cumulative abnormal return (CAR), is the total of all abnormal returns. Usually, the calculation of
    cumulative abnormal return happens over a small window of time, often only days. This short
    duration is because evidence has shown that compounding daily abnormal returns can create bias in
    the results. Cumulative abnormal return (CAR) is used to measure the effect of lawsuits, buyouts, and
    other events have on stock prices. Cumulative abnormal return (CAR) is also useful for determining
    the accuracy of asset pricing model in predicting the expected performance.

    The capital asset pricing model (CAPM) is a framework used to calculate a security's or portfolio's


    expected return based on the risk-free rate of return, beta, and the expected market return. After the
    calculation of a security's or portfolio's expected return, the estimate for the abnormal return is by
    subtracting the expected return from the realized return. The abnormal return may be positive or
    negative, depending on the performance of the security or portfolio over the specified period.

    KEY TAKEAWAYS

     An abnormal return describes the unusual profits generated by a specific security or portfolio
    over a period of time.
     Abnormal returns, which can be either positive or negative, determine risk-adjusted
    performance.
     A cumulative abnormal return is the total of all abnormal returns.
     CAR is used to measure the effect of lawsuits, buyouts, and other events have on stock prices.

    Real World Example


    Assume that the risk-free rate of return is 2% and the benchmark index has an expected return of 15%.
    An investor holds a portfolio of securities and wishes to calculate his portfolio's abnormal return
    during the previous year.
    The investor's portfolio returned 25% and had a beta of 1.25 when measured against the benchmark
    index. Therefore, given the amount of risk assumed, the portfolio should have returned 18.25 %, or
    (2% + 1.25 x (15% - 2%)). Consequently, the abnormal return during the previous year was 6.75% or
    25 to 18.25%.

    The same calculations can be helpful for a stock holding. For example, stock ABC returned 9% and
    had a beta of 2, when measured against its benchmark index. Consider that the risk-free rate of return
    is 5% and the benchmark index has an expected return of 12%. Based on the capital asset pricing
    model (CAPM), stock ABC has an expected return of 19%. Therefore, stock ABC had an abnormal
    return of -10% and underperformed the market during this period.

    Reference:
    https://www.investopedia.com/terms/a/abnormalreturn.asp

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