DEFINITION of 'Event Study'
An event study is an empirical analysis performed on a security that has experienced a significant catalyst occurrence, and has subsequently changed dramatically as a result. Examples of events that influence the value of a security include a company filing for Chapter 11 bankruptcy protection, the positive announcement of a merger or the result of the company defaulting on its debt obligations. Event studies can reveal important information about how a security is likely to react to a given event, and can help predict how other securities are likely to react to different events.
BREAKING DOWN 'Event Study'
An event study is an analysis of the impact of a specific piece of news or event directly or indirectly related to a company and its stock. It can also be used as a macroeconomic tool to analyze the impact of an event on an industry, sector or overall market. The study, whether it is on the micro or macro environment, tries to understand if a specific event has, or will have, an effect on a business' or economy's financial performance. An event study conducted on a specific company looks at the changes in its stock price relative to the news or event. A study on the overall market looks at the effects of the change in supply and demand.
Event Study Methodology
A stock price, according to modern financial theory, takes into account all available information and expectations about the future. This is why people are taught a stock's price is equal to its current price plus the summation of its expected future dividends. If this theory holds true, it is possible to analyze the effect of a specific event on a company by looking at the associated impact on the firm's stock. Event study analysis represents the statistical methodology and process for making these assessments.
The market model is the most common analysis used for event study methodology. It looks at the actual returns of a baseline reference market and tracks the correlation of a firm's stock with the baseline. This model tracks the abnormal returns on the specific day of an event and is meant to represent the difference between the stock's return on that day versus the normal or average return. The difference is the effect of the event on the company.
The market model can be used to analyze consecutive days and sum the differences together to understand how an event affects a stock over time. The idea is if the same type of model is used to analyze multiple events of the same type, it can predict how stock prices typically respond to a specific event.