Testing for Market Efficiency: A Comparison of the Cumulative Average Residual Methodology and Intervention Analysis

During the past decade considerable empirical evidence has been accumulated suggesting the stock market adjusts to the arrival of new information in an efficient manner. The studies providing this evidence consist of announcement tests of new publicly available information (such as earnings, stock splits, accounting changes, etc.) on the risk-adjusted return of securities. The specific methodology employed is crucial since it directly affects the results of a test for market efficiency. Following the pioneering work of Ball and Brown [1] and Fama, et al. [15], many researchers [6, 12, 21, 22, 27] have employed a similar methodology in order to test for market efficiency. This cumulative average residual (CAR) methodology consists of: (1) estimating the parameters of the market model based on data in a time period prior (and sometimes subsequent) to an announcement, and (2) analyzing the residuals derived from applying this model to a time period which includes the announcement date.

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