You Are Testing the Effect of Merger Announcements on Stock

question 84

Essay

You are testing the effect of merger announcements on stock prices.(This type of testing is called an "event study.") Your procedure is as follows:
Step 1: You select the twenty biggest mergers of the year.
Step 2: You isolate the date the merger becomes effective as the key date around which you will examine the data.
Step 3: You look at the returns for the five days after the effective merger date.
After looking at the returns in step 3 (you found an average of 0.13%),you conclude that you could not have made money on merger announcements.Are there any flaws that you can detect in this test? How could you correct for them? Can you devise a stronger test?

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Definitions:

Steps

A sequence of actions or methodical process to accomplish an end.

Organic Product

A compound or substance that contains carbon atoms bonded to hydrogen or other elements, primarily produced by living organisms but also synthesized in laboratories.

Reaction

A process in which substances interact to form new substances with different properties.

Transformation

The process of changing the structure or properties of a molecule, often used in context with chemical transformations.