Abnormal Return

Key Highlights

• The abnormal return is the difference between the actual return and the expected return.

• Abnormal Return = Actual Return−Expected Return

What is Abnormal Return?

The abnormal return is the difference between the actual return and the expected return. This can be due to factors such as political or economical events, changes in the company's fundamentals, or market sentiment.

How Abnormal Return is Calculated?

Abnormal return is basically an unprecedented profit or loss. The abnormal return is calculated by subtracting the expected market return from the realized return.

The formula for calculating abnormal return is:

Abnormal Return = Actual Return−Expected Return

Where:

Actual Return: The return generated by the investment across a certain period.

Expected Return: The anticipated return based on models like the Capital Asset Pricing Model (CAPM) or historical data, which considers the investment's risk profile.

Importance of Abnormal Returns

• Analyse Performance: It helps investors decide whether, given the bigger market, their decisions truly offer value.

• Measuring Risk: Investors can assess if the extra benefits offset the risks they’re taking.

• Spotting Market Trends: If abnormal returns continue, it could indicate that the market is not entirely efficient—probably in response to unanticipated events or news

In short, abnormal returns give investors a clearer picture of what’s really happening with their investments!