In this article I will explain you abnormal return definition and calculation of simple and cumulative abnormal return.

Abnormal return definition

In the world of stock market trades, the financial performance by a single stock or portfolio of stocks that varies from the market average is referred to as the accepted abnormal return. An abnormal return can be positive or negative. Whether it is positive or negative it all depends on whether the stock outperformed or underperformed the average market performance.

This abnormal return definition does not refers to an artificial or hypothetical measure, rather than that it refers to financial gains and losses measured against an actual index.

Market average

The performance of a broad-based index is defined as the market average. In the United States, the Standard & Poor’s 500 is an example of a widely-followed index, while for purposes of determining abnormal returns other areas may index their market average to their own national markets.

Abnormal Return Calculation

It is simple to calculate the initial abnormal return.

It is calculated by subtracting the index performance (which is usually expressed as a negative or positive percentage) from the individual stock or portfolio’s performance.

It provides a crude measure for the stock’s performance

By this calculation a crude measure is provided for the stock’s performance at a specific time, but fluctuations that naturally occur over a given period of time are not taken into consideration.

Cumulative abnormal return calculation

If you are willing to account for these normal variations, the percentage sum of all abnormal returns over a defined period of time is referred to as the cumulative abnormal return calculation.

Simple Abnormal return formula

Thus, we can express the simple abnormal return formula as:

(performance of individual stock or portfolio) – (index performance) = (abnormal return)

Cumulative Abnormal return formula

We can express the cumulative abnormal return formula as:

(sum of all daily abnormal returns of individual stock or portfolio) – (sum of all daily index performances) = (cumulative abnormal return)

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