Cumulative Abnormal Return (CAR): Calculation & Investment Decisions

Abnormal Return

Cumulative abnormal return is a financial term used to describe the value of an investment. Specifically, it describes the relationship between the expected value of a stock given the performance of the market as a whole and the stock's actual value. Knowing how to calculate cumulative abnormal return will help you make more informed investing decisions regarding the purchase of new financial instruments.

Step 1

Determine the market return for one day. This is the amount that the market increased or decreased in value.

Step 2

Determine the return on an individual stock for one day. This is the amount that the specific stock increased or decreased in value.

Step 3

Subtract the market return from the return on the individual stock. The result is the abnormal return. For example, if the market return was 10 points and the stock return was 15 points you would subtract 10 from 15 to get an abnormal return of 5 points.

Step 4

Repeat steps 1 through 3 for each of the days that fall within your chosen time-frame. For example, if you wanted to calculate the cumulative abnormal return of a stock over a period of four days you would need to repeat steps 1 through 3 a total of four times, once for each of the four days.

Step 5

Add the abnormal returns from each of the days. The result is the cumulative abnormal return. For example, if you were calculating the cumulative abnormal return for a period of four days and the abnormal returns were 2, 3, 6, and 5, you would add these four numbers together to get a cumulative abnormal return of 16.