Question

Briefly explain the intuition behind how CARs are used in event studies.   

Answer 1

CAR or Cumulative Abnomrmal returns are used to empirically investigate whether returns(positive or negative) in a particular security is due to an event that occured specific to a security or a group of securities. This would provide a relationship, ie a correlation between the event and the security return thus establishing the significance of event in the security movement.

Typically event studies have an estimation window to estimate the expected returns during the event window( time period around actual event taking place typically +5 to -5 days) using any models like CAPM etc. Once the returns are estimated, the actual returns in the event window are compared to the estimated returns and the difference between the two is considered as the abnormal returns. The post event window is also sometimes considered to estimate the abnormal returns. The abnormal returns are cumulatively added during the event window to obtain the cumulative abnormal returns (CAR) . The t statistic of CAR returns with null hypothesis that mean day excess return is zero.

The underlying intuition behind using CAR is that any event having a realtionship with securities will tend to establish a significant correlation with the returns.