What is abnormal return?

It’s a term used to describe how the actual returns on particular financial securities differ from their predicted return. The results can be perceived either positively or negatively, depending on the portfolio and the state of the securities.

Where have you heard about abnormal return?

Abnormal returns are not uncommon, and they can be caused by a number of different reasons and events. Company lawsuits, mergers, earnings announcements or any sort of newsworthy incident involving the security or portfolio can trigger returns that differ from their original prediction.

What you need to know about abnormal return...

Knowledge of abnormal returns is especially useful when comparing a security's risk-adjusted performance with the performance of the overall market. The value of these returns is a good measure for investors when determining if they have been properly compensated for the level of risk that has been taken. The system used to calculate a particular security or portfolio’s expected return is based on the risk-free rate of return, beta and expected market return. This is called the capital asset pricing model (CAPM).

The formula used is:

The actual return - the expected return = the abnormal return.