| Abstract: | The market model is commonly used in finance to study events and to evaluate security performance. With daily data, it is not uncommon to find low R-squares, in the range 0–10%. Prior studies have attempted to improve the fit of the model by excluding observations associated with high trading volume. In this study, we compare the results of the high-volume-exclusion approach with the more direct firm-specific announcement exclusion approach. The announcement approach excludes observations associated with Wall Street Journal Index news items regarding the firm. By excluding the −1,0] fays relative to such news in a sample of 68 firms, we find that R-squares increase significantly by about 5%. By excluding the days relative to earnings announcements only, R-squares increase by about 4%. These results are then compared to the high-volume-exclusion approach. It is found that this approach is more efficient as an 8% increase in R-squares is produced.The results of this study provide valuable evidence to empiricists by comparing the two approaches to improving the fit of the market model. The high-volume -exclusion approach provides higher R-squares. However, the relative efficiency of the two approaches should be balanced against the arguments for the methodologically correct approach. The advantage of using the firm-specific announcement exclusion approach is that there is more confidence of excluding only firm-specific movements from the estimation of the market model. It also allows a researcher to quickly and unambiguously identify the announcements and delete the corresponding observations. Furthermore, we find that about 50% of the improved fit, relative to the volume approach, can be accomplished by excluding earnings announcements. The methodological disadvantage of using the high-volume-exclusion approach is that it is affected not only by firm-specific announcements but also by other factors, such as the heterogeneity of investor expectations. These factors may influence the choice of using firm-specific announcements rather than the high-volume approach despite the lower increment in R-squares. |
