Event Studies and Efficient Markets

I do not find event studies interesting or convincing. I consider them an example of Schizzo-finance in which the efficient markets hypothesis is switched on and off. The field embraced that hypothesis for a while and I don’t think people understand how often they rely on it.

In an event study, the effect of a change on asset fundamental values is assessed by measuring the change in asset prices at the moment news of the change becomes publicly available. By fundamental value I mean the hold to maturity value of assets (or hold forever for assets like stock which last indefinitely. By the efficient markets hypothesis, I mean the semi strong version such that publicly available information can’t be used to get extraordinary risk adjusted returns. Ordinary risk adjusted returns are the returns one would get under rational expectations, that is, if everyone understood the economy (although the efficient markets hypothesis is always stated as a claim that asset prices act as if everyone had rational expectations not the claim that everyone does).

The fundamental role of the assumption that markets are semi-strong efficient in the approach is that it is assumed that perceived fundamental value can only change due to news. If agents must learn the relationship between events and, say, future dividends, interest payments, principal repayments and proceeds from bankruptcy procedures, then the price will not immediately correspond to the change in the distributions of these future variables.

This means that the hypothesis that something will substantially affect asset fundamental values is only refuted by event studies only if almost no one believes the hypothesis. If some believe it, their beliefs will cause asset prices to jump on the news. If they all learn they were wrong, the econometrician who relies on event studies will be the very last to learn, since the old miss-perceptions affect his final calculation via the assumption that asset prices are and always have been exactly what they would be if everyone understood everything.