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Time series and cross-section parameter stability in the market model: the implications for event studies

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  • J. Andrew Coutts
  • Terence Mills
  • Jennifer Roberts

Abstract

This paper investigates the time series and cross-section stability of parameter estimates from the single-index market model, using a UK data set relating to the security prices of parent companies, divesting in the form of a management buyout. A battery of tests of structural stability are undertaken, and we find that instability exists in the vast majority of the fitted models, both in relation to changes in the estimation period, and also to changes in the cross-section sample of firms included in this analysis. The implications of instability for the event study method are clearly illustrated by the construction of recursive cumulative abnormal return series. Our results suggest that when the market model is used within the event study framework, the quantitative results are extremely sensitive to the chosen estimation period and cross-section sample of firms. We suggest that if event studies continue to be pursued in the applied finance literature, it is essential that tests of parameter stability are incorporated into this framework. In addition, 'sensitivity analysis', that is, changes to the estimation period and cross-section sample employed, should also be investigated, and conclusions should be limited to interpreting the patterns of the cumulative abnormal returns.

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File URL: http://www.tandfonline.com/doi/abs/10.1080/135184797337462
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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal The European Journal of Finance.

Volume (Year): 3 (1997)
Issue (Month): 3 ()
Pages: 243-259

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Handle: RePEc:taf:eurjfi:v:3:y:1997:i:3:p:243-259

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Related research

Keywords: Single-INDEX Market Model Parameter Estimates Time Series Cross-SECTION Stability;

References

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  1. Handa, Puneet & Kothari, S. P. & Wasley, Charles, 1989. "The relation between the return interval and betas : Implications for the size effect," Journal of Financial Economics, Elsevier, vol. 23(1), pages 79-100, June.
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  11. Hall, Stephen G & Miles, David K & Taylor, Mark P, 1989. "Modelling Asset Prices with Time-Varying Betas," The Manchester School of Economic & Social Studies, University of Manchester, vol. 57(4), pages 340-56, December.
  12. Fabozzi, Frank J. & Francis, Jack Clark, 1978. "Beta as a Random Coefficient," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 13(01), pages 101-116, March.
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  14. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
  15. Ferson, Wayne E. & Foerster, Stephen R., 1994. "Finite sample properties of the generalized method of moments in tests of conditional asset pricing models," Journal of Financial Economics, Elsevier, vol. 36(1), pages 29-55, August.
  16. Fama, Eugene F, 1991. " Efficient Capital Markets: II," Journal of Finance, American Finance Association, vol. 46(5), pages 1575-617, December.
  17. Sunder, Shyam, 1980. " Stationarity of Market Risk: Random Coefficients Tests for Individual Stocks," Journal of Finance, American Finance Association, vol. 35(4), pages 883-96, September.
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  20. Terence Mills & J. Andrew Coutts, 1996. "Misspecification testing and robust estimation of the market model: estimating betas for the FT-SE industry baskets," The European Journal of Finance, Taylor & Francis Journals, vol. 2(4), pages 319-331.
  21. Edgerton, David & Wells, Curt, 1994. "Critical Values for the Cusumsq Statistic in Medium and Large Sized Samples," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 56(3), pages 355-65, August.
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Cited by:
  1. C Conn & A Cosh & P Guest & A Hughes, 2001. "Long-Run Share Performance of UK Firms Engaging in Cross-Border Acquisitions," ESRC Centre for Business Research - Working Papers wp214, ESRC Centre for Business Research.
  2. Robert L Conn & Andy Cosh & Paul M Guest & Alan Hughes, 2003. "The Impact on U.K. Acquirers of Domestic, Cross-border, Public and Private Acquisitions," ESRC Centre for Business Research - Working Papers wp276, ESRC Centre for Business Research.

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