What it means
If a share rises 3% on a day the whole market rises 3%, nothing special happened to that company. If it rises 3% on a day the market fell 2%, something company-specific drove a gain of roughly 5% more than expected.
That 5% is the abnormal return. The concept separates the part of a return that comes from simply being invested in the market from the part that comes from news, skill or luck attached to one particular security.
The "expected" return has to come from a model. The simplest approach uses the market return itself as the benchmark.
A more careful version uses the Capital Asset Pricing Model (CAPM), which adjusts for how sensitive the share is to market moves (its beta). A share with a beta of 1.5 is expected to rise 1.5% for every 1% the market rises, so its abnormal return is measured against that higher hurdle.
Multi-factor models add further adjustments for company size, value characteristics and momentum. Abnormal returns are the backbone of event studies, the standard method academics and analysts use to ask whether an event mattered.
By adding up abnormal returns over the days around an announcement (the cumulative abnormal return, or CAR), you can measure how much value the market believes the event created or destroyed. The same idea underpins fund performance measurement: a fund manager's alpha is essentially a persistent abnormal return after adjusting for the risks the fund took.
In practice
Real-world examples.
Example
A retailer reports quarterly earnings well above forecasts and its shares jump 8% on a flat market day. The abnormal return of about 8% measures the surprise.
Example
A bank is fined by a regulator and its shares fall 4% while the banking index rises 1%. The abnormal return of roughly minus 5% captures the market's verdict on the fine.
Example
A fund manager returns 14% in a year when a portfolio with the same risk should have returned 11%. The 3% abnormal return is the manager's alpha for that year.
Think of it
“Abnormal return is the extra return beyond what you'd expect given market movements-your excess gain or loss.
Formula
Calculation
Abnormal Return = Actual Return minus Expected Return
Using CAPM for the expected return:
Expected Return = Risk-free rate + Beta x (Market Return minus Risk-free rate)
Worked example. A pharmaceutical company announces successful trial results. On the announcement day:
- The share rises from $40.00 to $44.80, an actual return of 12.0%
- The market index rises 0.8%
- The risk-free rate for one day is close to zero, so we treat it as 0%
- The share's beta is 1.2
Expected return = 0% + 1.2 x (0.8% minus 0%) = 0.96%
Abnormal return = 12.0% minus 0.96% = 11.04%
Over the three-day window around the announcement the abnormal returns were 0.5%, 11.04% and minus 0.9%, giving a cumulative abnormal return of 10.64%. The market judged the trial news to be worth roughly 10.6% of the company's value.Case study
Seen in the real world.
An industrial group announced the acquisition of a competitor at a 35% premium. The acquirer's shares fell 6% on the day while the sector index rose 1%, an abnormal return of about minus 7%, or roughly $420 million of market value. The target's shares rose 31%.
The board had expected investors to applaud the deal's strategic logic. The abnormal return told them, in a single number, that investors believed the group was overpaying by something close to the premium.
Management responded by publishing a detailed synergy plan and committing to a share buyback funded by disposals. Over the following month the cumulative abnormal return recovered to about minus 2%, suggesting the market had partly, but not fully, accepted the case.
Watch out
Common mistakes.
- Comparing a share's return with the market's without adjusting for beta. A high-beta share is expected to move more than the market, so a raw comparison overstates its abnormal return in rising markets.
- Measuring over too wide a window. The longer the period, the more unrelated news creeps in and the less the abnormal return says about the event you care about.
- Assuming an abnormal return proves cause and effect. Other news may have arrived on the same day.
Questions
People also ask.
Is a positive abnormal return always good news?
For the shareholder who already owns the stock, yes. For someone deciding whether to buy, it means the good news is now in the price.
How is abnormal return different from alpha?
Alpha is an abnormal return that persists over time and is attributed to skill; a single abnormal return may be luck or a one-off event.
Can abnormal returns be calculated for bonds or funds?
Yes. Any asset with an expected return from a benchmark or model can have an abnormal return measured against it.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related