Abnormal returns: Econometric problems or psychological bias?

Abstract

To validate the existence of abnormal returns, the most of empirical studies use the event study methodology which examines the behavior of firms' stock prices around corporate event. However, this methodology was been the source of several limits. Some defenders of efficiency theory assert that the abnormal returns are due to the event study methodology failures and econometric problems. However, partisans of behavioral finance demonstrate that the abnormal returns are due to psychological bias. The main purpose of this paper is to verify if the abnormal returns resulting from the event study methodology are due to econometric problems or to psychological bias generated by irrational investors' reactions. For the econometric bias, five problems are studied: the choice of market index; the missing observations; the abnormal returns normality, joined hypothesis; and the variance volatility in the event window. Results show that abnormal returns are far from being due to the event study methodology failures and econometric bias. For the psychological problems, based on trading volumes, the results show negative and significant abnormal returns (investors' under-reaction); a strong positive correlation between abnormal returns and abnormal trading volumes and a significant causal sense between them. So, abnormal returns are due to psychological bias.