Abnormal stock returns, for the event firm and its rivals, following the event firm's large one‐day stock price drop

Abstract

Purpose

The purpose of this paper is to examine intra‐industry contagion and the following apparent violations of the efficient market hypothesis around large one‐day price decline events in individual stocks.

Design/methodology/approach

The paper examines daily stock returns around one‐day price declines of 10 percent or more for event stocks and their rivals. Using techniques similar to those used in Bremer and Sweeney and Cox and Peterson, the paper includes event stocks whose prices are at least $10 per share prior to the event to reduce the possible price reversal induced by bid‐ask price bounce. As is typical for the literature, the stock daily abnormal return (AR) is calculated as the difference between the actual daily stock return and the estimated stock return based on the market model estimated over a 200‐trading‐day pre‐event period [−220, −21]. Cumulative abnormal returns (CARs) for each stock are formed by aggregating the individual daily stock ARs. Denoting the large price decline event day as day 0, we examine the ARs of 41 trading days [−20,+20], the CARs for the [+1,+3] period, and the CARs for the [+4,+20] period. Cross‐sectional average ARs and CARs are calculated and tested for statistical significance. Furthermore, the paper examines whether the post‐event abnormal stock returns for the event firm and its rivals can be explained by prior event firm and industry variables.

Findings

On average, after an event, the event stock experiences a positive three‐day AR (S&P 600 stocks) followed by a 17‐day negative AR (both S&P 500 and 600 stocks). Moreover, for that 17‐day period: the rivals' stocks outperform the event firms' stocks and the event firms' returns are statistically significantly related to prior variables. The paper also finds statistically significant relationships between the prior variables and the rivals' post‐event stock returns. It provides an intra‐industry effects explanation for these results.

Originality/value

The paper offers insights into abnormal stock returns, for the event firm and its rivals, following the event firm's large one‐day stock price drop.

Citation

Yu, S. and Leistikow, D. (2011), "Abnormal stock returns, for the event firm and its rivals, following the event firm's large one‐day stock price drop", Managerial Finance, Vol. 37 No. 2, pp. 151-172. https://doi.org/10.1108/03074351111103686