Final answer:
The abnormal return in an event study is the difference between the actual rate of return and the expected rate of return due to a specific event. It helps to assess the impact of that event on the value of an investment. Understanding the deviation provides insight into the investment's risk and the event's influence.
Step-by-step explanation:
In an event study, the abnormal return is described as the difference between the actual rate of return and the expected rate of return over a specific time period around an event. The expected rate of return is a projection of future profits based on historical averages or other predictive models, typically expressed as a percentage.
Risk is the likelihood that the actual returns will differ from the expected returns, which can be influenced by various factors like default risk and interest rate risk. In contrast, the actual rate of return is the true gain or loss realized from the investment at the end of a certain period, accounting for both capital gains and interest.
A high-risk investment tends to have a wider deviation from the expected rate of return, demonstrating higher variability. Conversely, a low-risk investment usually has actual returns that closely track its expected returns. When analyzing the impact of an event on stock prices, for example, researchers calculate the abnormal return to determine whether the event had a significant effect on the company's value, beyond what was anticipated by the market.