Abnormal ReturnCAR
An abnormal return is the gap between what an investment actually returned and what it was expected to return given risk and market conditions. It isolates the part of a move caused by news, such as earnings or a merger.
A stock jumps 6% on earnings day. Was that the news, or did the whole market rally? Abnormal return answers this by subtracting the expected return. It's the core tool of event studies and helps traders judge whether a move was truly stock-specific. This entry explains the formula, how expected return is estimated and how to read the result.
- Category
- Fundamentals and Macroeconomics
- Reading time
- 3 min
- Also called
- Abnormal returns, Excess return around events, Cumulative abnormal return
- Updated
Abnormal return in plain words
Abnormal (or excess) returns are returns that exceed what is expected based on risk and market conditions.1
The formula is simple: abnormal return = actual return − expected return.1
Expected return is often estimated with a model like CAPM, using the risk-free rate, beta and the market's return.2
How to measure abnormal return, step by step
Pick the event
Earnings, merger, guidance. See Earnings Surprise.
Estimate expected return
Market model or CAPM. See Capital Asset Pricing Model.
Measure actual return
Over the event window.
Subtract
Actual − expected.
Add up over days
Gives cumulative abnormal return (CAR).
Compare across events
Look for consistent patterns.
Worked examples
Example 1 — Earnings day
+5% abnormalA stock with beta 1.0 rises 6% on earnings day while the index rises 1%.
| Expected | ≈ 1% |
| Actual | 6% |
| Abnormal return | +5% |
Subtracting the expected return isolates how much the news itself moved the price.1
Example 2 — CAPM expected return
−2% abnormalRisk-free 4%, market return 10%, beta 1.5. The stock returned 11% for the year.
| Expected (CAPM) | 4% + 1.5 × (10% − 4%) = 13% |
| Abnormal return | 11% − 13% = −2% |
CAPM sets the expected return from beta and the market risk premium.2 A positive raw return can still be abnormally weak.
Example 3 — Cumulative abnormal return
CAR +5%Over three days around a merger announcement, abnormal returns are +4%, +1.5% and −0.5%.
| CAR | 4 + 1.5 − 0.5 = +5% |
Adding daily abnormal returns over an event window shows the total reaction to the news. See Mergers and Acquisitions.
Abnormal return vs related measures
| Aspect | Measures | Benchmark |
|---|---|---|
| Abnormal return | Actual − expected | Model-based expected return |
| Alpha | Risk-adjusted outperformance | CAPM or factor model |
| Relative return | Actual − benchmark | An index |
| Excess over cash | Actual − risk-free | T-bill rate |
Where abnormal returns are used
Event studies
Measuring news impact.
Earnings trading
Judging true reactions. See Earnings Season.
Fund evaluation
Linked to alpha. See Alpha.
Market efficiency tests
Advantages and disadvantages
Advantages
- Separates stock news from market moves.
- Simple to calculate.
- Standard tool in finance research.
Disadvantages
- Depends on the expected-return model.
- Noisy over short windows.
- Hard to separate overlapping news.
Going deeper
Read as far as you need. Each level builds on the one before it.
Not the same as profit
Beginner
A stock can rise and still have a negative abnormal return if it lagged what was expected given its risk.1
Choosing the model
Intermediate
Simple studies use the market return; others use CAPM or multi-factor models, and results can change with the model chosen.2 See Factor Investing.
Post-event drift
Advanced
Studies have found abnormal returns that continue for weeks after earnings surprises, a challenge to strong market efficiency. See Earnings Season.
Common mistakes
Ignoring the market's move
Raw returns mislead.
Wrong beta
Use a sensible estimation period.
Window too long
Other news creeps in.
One event as proof
Patterns need many events.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- Abnormal return = actual − expected return.
- Expected return often comes from CAPM or a market model.
- It isolates the effect of news.
- CAR adds abnormal returns over an event window.
- Results depend on the model chosen.
Frequently asked questions
Is abnormal return the same as alpha?
Can abnormal returns be negative?
What is an event window?
Further learning
- Capital Asset Pricing Model
Estimating expected return.
- Alpha
The portfolio equivalent.
- Earnings Surprise
A common event.
- Efficient Market Hypothesis
What abnormal returns test.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- Corporate Finance Institute. Abnormal Return (opens in a new tab) Checked .
- Corporate Finance Institute. CAPM Formula (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.