Wednesday, November 17, 2004

Right angles in event studies are good :)

In running or biking I am not a fan of 90 degree angles, but in event studies, I love them! An abrupt (straight up or straight down-i.e. a right angle) price movement following an "event" suggests that the news was both unanticipated and the market quickly incorporated the new information.

A right angle going forward suggests that the market not only was quick about incorporating the news, but that investors correctly interpreted the news.

In this context let's take a fast look at the "surprise" merger of Kmart and Sears.'> Kmart, Sears to Merge in $11 Billion Deal: "Kmart, Sears to Merge in $11 Billion Deal "

Was it a surprise? It sure seems it! In yesterday's trading neither Kmart nor Sears experienced abnormal trading. In fact both had relatively low volume. So the announcement most likely took the whole market by surprise.

Immediately following the announcement, the stock prices jumped.

Now this happened before the NYSE is opened, so we will have to rely on price quotes from ECNs. According to Archipelago, Sears is up 21% while Kmart is up just over 10%. Which also suggests strongly that those trying to profitably trade on overnight information would have a difficult time doing so on the major exchanges where the stock price "open" at the higher price.

So the lesson? Right angles in event studies suggest semi-strong form market efficiency!

As an aside, years ago this horizontal merger (two firms in tea same industry) might have bumped up against significant regulatory pressure , but as the market shares of each firm has fallen, so too will serious pressure to block the deal as anticompetitive.

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