Idiosyncratic volatility change and event study tests

Nihat Aktas, Eric de Bodt and Jean-Gabriel Cousin ()
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Nihat Aktas: EM - EMLyon Business School
Eric de Bodt: Université Lille Nord (France)
Jean-Gabriel Cousin: Université de Lille, Université Lille Nord (France)

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Abstract: The idiosyncratic volatility is a key input to the standard event-study method. The recent literature has suggested that the idiosyncratic volatility is not stable through time. This paper investigates the extent to which the event-study method is affected by this economic phenomenon. Using both simulation and real dataset analyses, we show that standard event-study methods suffer from a significant loss of power in the presence of increasing idiosyncratic volatility, as intuition would suggest. This affects the comparability of event study results obtained in two different empirical contexts (time periods or geographical zones). Therefore, to compare results between high and low regime of idiosyncratic volatility on a fair ground, everything else being equal, the ratio of the sample sizes needs to be equal to the ratio of the idiosyncratic variances in the two contexts.

Date: 2009-07-01
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Published in Finance, 2009, 30 (2), 31-61 p. ⟨10.3917/fina.302.0031⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-02312554

DOI: 10.3917/fina.302.0031

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