Event studies with a contaminated estimation period

Abstract

Event studies are an important tool for empirical research in Finance. Since the seminal contribution of Fama et al. [Fama, E., Fisher, L., Jensen, M., Roll, R., 1969. The adjustment of stock prices to new information. International Economic Review 10, 1–21], there have been many enhancements to the classical test methodology. Somewhat surprisingly, the estimation period has attracted less interest. It is usually routinely determined as a fixed window prior to the event announcement day. In this study, we propose a test that reduces the impact of potentially unrelated events during the estimation period. Our proposition is based on a two-state version of the classical market model as a return-generating process. We present standard specification and power analyses. The results highlight the importance of explicitly controlling for unrelated events occurring during the estimation window, especially in the presence of event-induced increase in return volatility