Assessing the Power and the Size of the Event Study Method Through the Decades

Abstract

The idiosyncratic risk is a key input of the standard event study method. The recent literature has suggested that the idiosyncratic risk is not stable through time, and it has increased significantly in the nineties. This paper investigates to what extent the event study method is affected by this economic phenomenon. Using both simulation and real dataset analyses, we show that the classical event study methods suffer from a significant loss of power due to increasing idiosyncratic risk, as the intuition suggests it. A (and maybe the only) solution to alleviate the impact of increasing idiosyncratic risk consists in increasing the sample size by a factor corresponding to the ratio of average idiosyncratic variances between the analyzed periods.

Keywords: event study, idiosyncratic risk

JEL Classification: G14, G34