Abnormal returns are sometimes triggered by "events."
Events can include mergers, dividend announcements, company earning announcements, interest rate increases, lawsuits, etc.
Events in finance can typically be classified as information or occurrences that have not already been priced by the market.
In stock market trading, abnormal returns are the differences between a single stock or portfolio's performance and the expected return over a set period of time.
If the market average performs better (after adjusting for beta) than the individual stock, then the abnormal return will be negative.
The calculation formula for the abnormal returns is as follows:[2]
where: ARit - abnormal return for firm i on day t Rit - actual return for firm i on day t E(Rit) – expected return for firm i on day t A common practice is to standardise the abnormal returns with the use of the following formula:[3]
where: SARit - standardised abnormal returns SDit – standard deviation of the abnormal returns The SDit is calculated with the use of the following formula:[2]
where: Si2 – the residual variance for firm i, Rmt – the return on the stock market index on day t, Rm – the average return from the market portfolio in the estimation period, T – the numbers of days in the estimation period.
[4] Cumulative Abnormal Returns are usually calculated over small windows, often only days.
This is because evidence has shown that compounding daily abnormal returns can create bias in the results.