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Investments
Case 1
Event studies: How Does the Stock
Price React to Important Events?
FIN 411 -- Investments
Examples of things you can do by analyzing
stock returns
Control for price behavior that is unrelated
to the event
market movements
industry movements
effects of other firm-specific events at the
same time
Data in Excel spreadsheets
"F411M.XLS" -- monthly data from 85-94
"F411D.XLS"-- daily data from 85-94
Remember: stock price reaction measures
the effect of new information
similar data in Eviews files f411D.WF1 &
F411M.WF1
i.e., revision of expectations
Polaroid - Kodak
Stock Returns, 1983-89
Polaroid & Kodak Had Protracted Litigation
Over Instant Photography Patent Rights
Many events over several years:
PRD reorganizes:
Layoffs & buyback
40%
Monthly Percentage Returns
two-phase trial:
(1) liability, then
(2) damages
appeals at every major outcome
security analysts were valuing both
companies based on the expected outcome
of the suit
Supreme Court won't
hear EK appeal
20%
10%
0%
-10%
-20%
EK will
appeal
EK seeks to
vacate rulings
Jul/89
Jan/89
Jul/88
Jan/88
Jul/87
Jan/87
Jul/86
Jan/86
Jul/85
Jan/85
Jul/84
Jul/83
Jan/84
Jan/83
-30%
Kodak & Sterling Drug Merger
Announced January 1988
Kodak was "White Knight" Bidder for
Sterling Drug Target
Kodak
0%
-20%
-40%
1-6
Jul/90
Jan/90
Jul/89
Jan/89
Jul/88
Jul/87
Jan/88
Jul/86
Jan/87
Jan/86
-60%
Jan/83
ε(it) = R(it) - α(i) - β(i) R(mt)
Merger
announcement
20%
Jul/85
then form prediction errors for 1/87-end:
Estimation Period: 1/83-12/86
40%
Jul/84
I estimated the market model using monthly
returns from 1/83 - 12/86
60%
Jan/85
On 1/22/88 Kodak offers $89.50/share for Sterling
Sterling
80%
Jul/83
Cumulative Abnormal Returns (12/86 = 0)
Hoffman-LaRoche bid $72/share for Sterling (STY)
in early 1988
Prof. Schwert
PRD seeks
$5.7 bil
damages
EK loses
round
PRD wins
patent suit
30%
Jan/84
FIN 411
Spring 1997
Investments
Case 1
GM Pursues
Large Diversifying Acquisitions
Performance of GM Stock
(Autos, EDS & Hughes)
GM
$1
GMH
Investment Opportunity Set
(Mean vs. Std Deviation)
Jul/90
Jul/89
Jan/90
Jul/88
Jan/89
Jan/88
Jul/87
Jan/87
Jul/86
Jan/86
Jul/85
$0
Jan/83
created new class of stock (GMH), linked to
Hughes profits
GM Acquires EDS
$2
Jul/84
bought Hughes Aircraft (defense
contractor) in auction
GME
GM Acquires Hughes
$3
Jan/85
created new class of stock (GME), linked to
EDS profits, and less strongly linked to the
auto business
the NYSE considered delisting GM for
having multiple classes of stock
$4
Jul/83
Value of $1 Investment Made in October 1984
bought Electronic Data Systems (EDS) Ross Perot company [recently spun-off]
Jan/84
FIN 411
Avg Returns vs. Standard Deviations
Rochester-related Stocks, 1984-93
Based on returns from 1984-93
4%
IV
STY
obviously these estimates contain some
estimation error
Average Monthly Returns
3%
usually would be surprised to see investors buy
stock if they expected returns to be negative
standard deviations are quite large for firms that
have major surprise events
PAYX
2%
Rme
RTC
XRX
Rmv
1%
RCSB
RGS
Rsp
KSM
EK
Rf
0%
HMX
IBM
means are quite large for firms that are targets in
takeovers (e.g., STY)
-1%
0%
5%
10%
15%
20%
Standard Deviations per Month
Capital Asset Pricing Model:
Avg Returns vs. Beta
Avg Returns vs. Betas
Rochester-related Stocks, 1984-93
Security Market Line:
4%
IV
STY
E[R(i)] = R(f) + β(i) { E[(R(m) - R(f)] }
Average Monthly Returns
3%
I drew a line from R(f) through E[R(m)], but I
also estimated a regression of average
returns on beta estimates
obviously these estimates contain a lot of
estimation error
EMF
BKHT
Estimated
Security Market
Line (regression)
2%
EK
Sharpe-Lintner
Security Market
Line (CAPM)
Rm
CMB
1%
XRX
KSM
Rf
0%
IBM
Note the abnormal performance for the
"Inefficient Market Fund"
Prof. Schwert
PAYX
HMX
-1%
0
0.5
1
1.5
2
Beta
7-12
Spring 1997