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IAI Actuarial Core Principles · Economic Modelling · Rational expectations theory and the efficient markets hypothesis

An event study examines the reaction of share prices to surprise dividend increases announced by Indian companies. In a semi-strong efficient market, which pattern of cumulative abnormal returns (CAR) would be expected around the announcement date?

In a semi-strong efficient market, prices jump at the announcement as the new public information is absorbed immediately, and no significant drift in cumulative abnormal returns follows. A continuing post-announcement drift would show slow adjustment and contradict semi-strong efficiency.

  1. AA jump in CAR on the announcement day with no significant drift afterwardsCorrect
  2. BA gradual rise in CAR over the 30 days following the announcement
  3. CA fall in CAR on the announcement day followed by a rise over the next month
  4. DNo change in CAR on the announcement day but a rise in the following year
  5. A steady fall in CAR before and after the announcement

Explanation

If public information is incorporated immediately, the price adjusts at the announcement and abnormal returns thereafter average zero. A gradual post-announcement drift would indicate a slow reaction, which is evidence against semi-strong efficiency.

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