Blog Post

Blogs review: The Events Study methodology

What’s at stake: The event study approach – a methodology in finance and economics used to detect the presence of event-induced returns within a period – has become ubiquitous in recent debates about the impact of unconventional monetary operations. But its identifying assumptions are generally not very well understood. In this review, we explain the […]

By: and Date: October 8, 2012 Topic: Macroeconomic policy

What’s at stake: The event study approach – a methodology in finance and economics used to detect the presence of event-induced returns within a period – has become ubiquitous in recent debates about the impact of unconventional monetary operations. But its identifying assumptions are generally not very well understood. In this review, we explain the different steps followed by researchers to perform event-study analyzes; we point out some of their pitfalls, based on recent discussions following the latest Jackson Hole meeting; and we illustrate its growing popularity in a variety of fields.

The econometric skeleton of an event study

The underlying idea of an event study is to use the high frequency trading values of financial securities to assess the impact of news. If financial markets are efficient, in the sense that information about the future payoffs of the assets are factored in their prices, an event that affect these future payoffs should translate into an immediate repricing. The impact of an event can thus be measured by examining security prices surrounding the event.

Craig MacKinlay writes in a 1997 paper of the Journal of Economic Literature that the event definition represents the first key step for conducing an event study. Starting with the selected event in period t, the interval of time t-1 and t+1 is defined as period over which the event occurs and the asset price will be analyzed. This interval – named “event window” – is usually larger than the specific event of interest because it is aimed at containing the ex post reaction of markets closed in t as well as possible ex ante reactions due to market expectations.

Once the event and the event window are defined, abnormal returns – the difference between the actual ex post return of the asset and the normal return over the event window – are estimated. There are several approaches for estimating normal returns, i.e. the returns that one would have expected in the absence of the event. Norman Strong gives an overview of the different approaches used to estimate the benchmark for abnormal returns.  Some assume a very simple data generating process – for example that the ex ante expected return for a security is a constant that can vary across firms – while others use a more complicated structure inspired by economic models like the CAPM or arbitrage pricing theory. After selecting these models, the normal return is estimated over a period of time called “estimation window” and defined in the range t-2 and t-1.

How much of the effect is due to news?

James Hamilton writes – about the impact the quantitative easing – that the hope is that, over the short period studied, the policy announcement itself is the most important news item to which markets were responding. But the problem plaguing any effort to measure the effects of the policy is the fact that the policy was certainly itself also a response to the news of a rapidly weakening economy, which would have been a reason for falling yields even if the Fed had done nothing. In his recent Jackson Hole paper, Michael Woodford points that the fact that the stock market has also declined in value during each of the periods when there were sustained declines in long-term bond yields supports this interpretation.

Michael Woodford furthermore points that the assumptions underlying the event studies methodology is inconsistent with the existence of the policy effects that the study is intended to demonstrate. Taking the sum of the market movements on these announcement days only as a measure of the cumulative effect of the program as a whole — rather than, say, the cumulative change in long-term interest rates over the entire period of the program — depends on believing that the program should only influence bond prices at the times when there is news that changes the expected size of the program, and that the effects of news are (nearly) immediate and permanent. The latter assumptions are familiar ones in event studies in financial economics, of course; but it is important to recall that the justification for this familiar methodology is an assumption that securities markets are “efficient,” so that expected returns looking forward from any point in time are essentially constant (which requires that the effects of news on prices be realized instantaneously and not be subsequently reversed). Such an assumption is not obviously consistent with the existence of effects of Fed purchases on the prices of securities that the study is intended to demonstrate; for if the quantity purchased influences the price of a security, then the market is not efficient in the Samuelson-Fama sense.

Beyond the problem of event clustering – which can be partly dealt by having a small event window – Michael Woodford points out that event studies cannot disentangle the channels through which the event has an effect. The one-day window is narrow enough that, in most cases, one can – for example – plausibly argue that the FOMC’s statement was the only big news affecting fixed-income markets that day; but it is less obvious that the only news in the statement was information about the likely size of the asset-purchase program. In particular, if the statement also contained information that changed expectations about the future path of the federal funds rate, then bond yields should have changed on those days, even in a world where there are no portfolio-balance effects.

Joseph Gagnon writes a seriously wonky rebuttal to Michael Woodford’s skepticism. Some Fed statements and actions clearly had no implications for the path of future short-term rates, and yet they still affected some asset prices. This evidence comes from a range of investigations, not solely from event studies, and the conclusion is not sensitive to changes in the underlying model used to identify movements in the term premium.

A research approach with growing popularity

The events-study methodology was introduced by Ray Ball and Philip Brown (1968) and Eugene Fama et al. (1969) in the late 60s, in the field of corporate finance. Ball and Brown assessed the impact of the information contained in the earnings whereas Fama et al. studied the effects of stock splits. Alongside the analysis of firm stock price’s reaction, a vast branch of the literature implemented event studies for the impact assessments of macroeconomic event or monetary policies decisions on bonds and exchange rate.

Many studies analyzed the impact of credit rating agencies decision. Most of them focus on the price reaction of both corporate and sovereign bond prices on rating decision on sovereign creditworthiness (see Vassalou and Xing for some references). Reisen, H. and J. von Maltzan (1999) examined the announcement of credit rating agencies’ decision emerging-market sovereign bonds and their impact on the dollar yield spreads. Earlier studies investigated also the behavior of Credit Default Swap (CDS) conditional to review of credit rating decision.

Another part of the literature focus on estimating the impact of monetary policy. Jonathan Kearns and Phil Manners (2005) investigated the impact of monetary policy on the exchange rate using intraday data. Jack Meaning and Feng Zhu (2011) analyzed the impact of the Federal Reserve’s Large-Scale Asset Purchase (LSAP) programme and the Bank of England’s Asset Purchase Facility (APF) on government bond yields. Eric T. Swanson (2011) present a more modern high-frequency event-study approach in order to estimate the potential benefits of FED’s QE2 by measuring the effect on long-term interest rates of Operation Twist.  Don Bredin and al. (2009) focused on the private sector reaction of monetary policy, with an event study on BoE and ECB on UK and German aggregate and sectoral stock returns. For further links, see Joseph Gagnon.

Apart from these contributions, the event study methodology has found application also beyond the fields of accounting and finance. For example, in the field of development economics, Eliana La Ferrara and Massimo Guidolin investigated in 2007 AER paper the impact of the sudden end of the civil war in Angola – marked by the death of the rebel movement leader – on the stock market value of diamond mining firms.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article More by this author
 

Blog Post

It’s hard to live in the city: Berlin’s rent freeze and the economics of rent control

A proposal in Berlin to ban increases in rent for the next five years sparked intense debate in Germany. Similar policies to the Mietendeckel are currently being discussed in London and NYC. All three proposals reflect and raise similar concerns – the increase in per-capita incomes is not keeping pace with increases in rents, but will a cap do more harm than good? We review recent views on the matter.

By: Inês Goncalves Raposo Topic: Macroeconomic policy Date: July 8, 2019
Read article More on this topic
 

Blog Post

The breakdown of the covered interest rate parity condition

A textbook condition of international finance breaks down. Economic research identifies the interplay between divergent monetary policies and new financial regulation as the source of the puzzle, and generates concerns about unintended consequences for financing conditions and financial stability.

By: Konstantinos Efstathiou and Bruegel Topic: Banking and capital markets Date: July 1, 2019
Read article More on this topic
 

Blog Post

The June Eurogroup meeting: Reflections on BICC

The Eurogroup met on June 13th to discuss the deepening of the economic and monetary union (EMU) and prepare the discussions for the Euro Summit. From the meeting came two main deliverables: an agreement over a budgetary instrument for competitiveness and convergence and the reform of the European Stability Mechanism (ESM) treaty texts. We review economists’ first impressions.

By: Bruegel and Inês Goncalves Raposo Topic: Macroeconomic policy Date: June 24, 2019
Read article More on this topic
 

Blog Post

The campaign against ‘nonsense’ output gaps

A campaign against “nonsense” consensus output gaps has been launched on social media. It has triggered responses focusing on the implications of output gaps for fiscal policy under EU rules, especially for Italy. But the debate about the reliability of output-gap estimates is more wide-ranging.

By: Konstantinos Efstathiou and Bruegel Topic: Macroeconomic policy Date: June 17, 2019
Read article More on this topic
 

Blog Post

The inverted yield curve

Longer-term yields falling below shorter-term yields have historically preceded recessions. Last week, the US 10-year yield was 21 basis points below the 3-month yield, a feat last seen during the summer of 2007. Is the current yield curve a trustworthy barometer for future growth?

By: Inês Goncalves Raposo and Bruegel Topic: Global economy and trade Date: June 11, 2019
Read article More on this topic
 

Blog Post

The 'seven' ceiling: China's yuan in trade talks

Investors and the public have been looking at the renminbi with caution after the Trump administration threatened to increase duties on countries that intervene in the markets to devalue/undervalue their currency relative to the dollar. The fear is that China could weaponise its currency following the further increase in tariffs imposed by the United States in early May. What is the likelihood of this happening and what would be the consequences for the existing tensions with the United States, as well as for the global economy?

By: Inês Goncalves Raposo and Bruegel Topic: Global economy and trade Date: June 3, 2019
Read article More on this topic
 

Blog Post

The next ECB president

On May 28th, EU heads of state and government will start the nomination process for the next ECB president. Leaving names of possible candidates aside, this review tries to isolate the arguments about what qualifications the new president should have and what challenges he or she is likely to face.

By: Bruegel and Konstantinos Efstathiou Topic: Macroeconomic policy Date: May 27, 2019
Read article More on this topic More by this author
 

Blog Post

The latest European growth-rate estimates

The quarterly growth rate of the euro area in Q1 2019 was 0.4% (1.5% annualized), considerably higher than the low growth rates of the previous two quarters. This blog reviews the reaction to the release of these numbers and the discussion they have triggered about the euro area’s economic challenges.

By: Konstantinos Efstathiou Topic: Macroeconomic policy Date: May 20, 2019
Read article More by this author
 

Blog Post

Is an electric car a cleaner car?

An article published by the Ifo Institute in Germany compares the carbon footprint of a battery-electric car to that of a diesel car, and argues a higher share of electric cars will not contribute to reducing German carbon dioxide emissions. Respondents rejected the authors’ calculations as unrealistic and biased, and pointed to a series of studies that conclude the opposite. We summarise the article and responses to it.

By: Michael Baltensperger Topic: Digital economy and innovation, Green economy Date: May 13, 2019
Read article More on this topic More by this author
 

Blog Post

All eyes on the Fed

Last week the US Federal Reserve left the federal funds rate unchanged and lowered the interest rate on excess reserves. We review economists’ recent views on the monetary policy conduct and priorities of the United States’ central bank system.

By: Inês Goncalves Raposo Topic: Global economy and trade Date: May 6, 2019
Read article More on this topic More by this author
 

Blog Post

Is this blog post legal (under new EU copyright law)?

How new EU rules on using snippets from news publishers and on copyright infringement liability might affect circulation of information, revenue distribution, market power and EU business competitiveness.

By: Catarina Midões Topic: Macroeconomic policy Date: April 8, 2019
Read article More on this topic
 

Blog Post

Secular stagnation and the future of economic stabilisation

Larry Summers’ and Łukasz Rachel’s most recent study documents a secular fall in neutral real rates in advanced economies. According to the authors, this fall would be even more marked in the absence of offsetting fiscal policies. Policymaking in a world of permanently low interest rates may be hard to navigate, especially in troubled waters. We review economists’ views on the matter

By: Inês Goncalves Raposo and Bruegel Topic: Macroeconomic policy Date: April 1, 2019
Load more posts