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Market-adjusted model - How to calculate returns?
 Posted: 12 February 2014 03:20 PM [ Ignore ]
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Total Posts:  28
Joined  2014-01-13

Hi guys,

I have a simple question. I wanna use the market-adjusted return model and I don’t know in which order I should do the calculations.

This is my data:
- Monthly stock returns of many firms and the monthly market index return over a period of 12 months
- I want to calculate the average abnormal annual return

What should I calculate first?

1) Monthly stock returns minus Monthly market index returns, then compound the monthly abnormal returns to get the annual abnormal returns and then take the average of all annual abnormal returns
2) Compound the monthly returns for the stocks as well for the market, take the average across all firms and then subtract the averages from each other
3) Compound the monthly returns for the stocks as well as for the market, subtract them from each other and then take the average

Which one is right?

Thanks

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 Posted: 13 February 2014 07:45 AM [ Ignore ]   [ # 1 ]
Total Posts:  901
Joined  2011-09-19

hi,

I would go for #1; the term abnormal return implies that it is raw firm return minus market return (or some other ‘expected’ return). Cumulative abnormal return implies summing this abnormal return over some period. Average cumulative abnormal return implies the average of the cumulative abnormal return.

best regards,

Joost

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 Posted: 19 February 2014 03:02 AM [ Ignore ]   [ # 2 ]
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Total Posts:  28
Joined  2014-01-13

Thanks Joost, this helped me.

I have another question regarding return models.
What famous models are there/have been emerged recently to calculate long-term abnormal returns (let’s say over a period of 3-5 years). I know the following:

- Buy and hold excess returns
- Calendar time portfolios
- Cumulative excess returns
- Fama French Model

Are there any other famous models for long-term returns?
Thanks

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 Posted: 21 February 2014 12:20 PM [ Ignore ]   [ # 3 ]
Total Posts:  901
Joined  2011-09-19

hi,

Your list makes sense; although I think the Fama French is used to compute ‘expected’ or ‘normal’ return. I think it would be good to search finance literature for guidance on implementing such models. I remember there are some common mistakes, but I am not up-to-date with this.

Feel free to post such references if you come across any.

thanks,

Joost

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