DETECTING ABNORMAL RETURNS USING THE MARKET MODEL WITH PRE‐TESTED DATA

A. Steven Graham, Wendy L. Pirie and William A. Powell

Journal of Financial Research, 1996, vol. 19, issue 1, 21-40

Abstract: The current literature suggests various alternative procedures for increasing the power of tests to detect abnormal returns in event studies. Using randomly constructed portfolios, we simulate events and compare the results of tests using three alternative procedures: traditional, cross‐sectional, and cross‐sectional with standardized residuals. For each test, we compare results when all observations are included with results when the observations with high trading volume are omitted from the estimation period. The simulation results indicate that both the traditional approach with omitted observations and the cross‐sectional approach using standardized residuals with all observations yield approximately the correct test sizes and significantly improve the power of tests to detect abnormal returns. However, the cross‐sectional approach using standardized residuals is clearly dominant among the three procedures.

Date: 1996
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