Financial Markets and Human Capital

Tutorial 5

Ernst Maug
University of Mannheim
http://cf.bwl.uni-mannheim.de
ernst.maug@uni-mannheim.de
Secretary: Angelika Wolf-Tobaben
cf.secretary@uni-mannheim.de
Tel: +49 (621) 181-1951
 Agenda

 No question posted to the forum

 Check list before submission

© 2023 Ernst Maug Financial Markets and Human Capital 2

 Question 1

 Is the estimation window the longer the better?

 No

 A longer estimation window contains more data points

  Smaller estimation error  stronger statistical power

 However, longer estimation windows also overweigh dated information

  Wrong estimate if a structural break within the estimation window
- E.g., A strategic shift drastically diversifies a firm’s product portfolio, and decreases its beta
- A long estimation window including such a structural break overstates the beta

© 2023 Ernst Maug Financial Markets and Human Capital 3

 Question 2

 Is the event window the longer the better? No, a longer event window might be more comprehensive, but is
also more susceptible to confounding events.

 Does it have to be symmetric?

 No, the event window is not necessarily symmetric
- In some context, a run-up does not logically exist, e.g., CEO turnover due to plane crash
- … or does it?

 Shall I play around with the event window to get the most statistically significant result?
 Bad practice!

© 2023 Ernst Maug Financial Markets and Human Capital 4

 Question 3

 I adopt the market model. How many degrees of freedom should I adjust for downward?

 Two.
 You estimate two coefficients for the market model: Alpha and beta

 How many degrees of freedom should you subtract if you employ the model below?

 You subtract four degrees of freedom.

© 2023 Ernst Maug Financial Markets and Human Capital 5

 Question 4

 How do I estimate the standard deviation of an abnormal return (AR)?

 You estimate it as the standard deviation of residuals of the market model in the estimation window (say t=-21
to t=-220)

© 2023 Ernst Maug Financial Markets and Human Capital 6

 Question 5

 How do I estimate the standard deviation of a cumulative abnormal return (CAR)?

 The “square root of N rule”

 Why?
 Assumption: All ARs within the event window are independent to each other, and follow an identical distribution
(i.i.d.)

© 2023 Ernst Maug Financial Markets and Human Capital 7