What Is an Abnormal Return?

Abnormal return is when investment returns veer way off from what you'd expect—they can be surprisingly high or disappointingly low. It's what happens when real returns don't match what we thought we'd get. Sometimes these weird fluctuations come from strange market stuff. Other times? Fund managers might be up to something fishy.

Don't mix up abnormal returns with Alpha or excess returns. Not the same thing. Those actually show if investment managers have skills. There's also this thing called Cumulative Abnormal Returns (CAR). It adds up all those abnormal returns over time. Pretty useful for seeing how outside events mess with stock prices.

Importance of Abnormal Returns

These abnormal returns really matter when you're checking how portfolios stack up against the market. They tell you something about the portfolio manager. Are they good with risk? And are investors getting paid enough for the risks they're taking?

One thing to remember: abnormal returns can go either way—positive or negative. They're just the gap between what actually happened and what should've happened. Makes them kind of perfect for comparing returns against the whole market.

Abnormal Return as an Evaluation Metric

Calculating these things helps investors figure out risk-adjusted performance compared to normal market stuff. It seems this is a good way to check if your investments are worth the trouble. The math isn't complicated. Just subtract what you expected from what you got.

Think about it. A mutual fund should give you 12% annually, but suddenly delivers 26%? That's a positive abnormal return of 14%. Nice! But if it only gives you 3%? That's a negative 9%. Not so nice.

Calculating Abnormal Returns

It's 2025 now. The pros typically use a few models to figure this stuff out:

1. The Market Model - compares actual stuff against benchmark stuff
2. Capital Asset Pricing Model (CAPM) - gets into risk-free rates and systematic risk
3. Fama-French Model - throws in more factors like size and book-to-market ratios

CAPM is still the crowd favorite. Not entirely clear why, but it does show how systematic risk connects to expected return. Once you know what you should expect, just subtract that from what you actually got. Boom—abnormal return.

Cumulative Abnormal Return (CAR)

CAR just adds up all those individual abnormal returns over time. It's kind of important. Why? Because looking at just one abnormal return might give you the wrong idea. CAR shows the bigger picture.

Examples of Abnormal Returns

Corporate stuff triggers these abnormal returns a lot. Earnings surprises. Unexpected profits. Big losses. These make stock prices jump around. In 2025, earnings announcements still shake things up, with good surprises creating about 2.3% in abnormal returns over a three-day period.

Share buybacks do things too. By 2025, buybacks should hit $1.9 trillion globally. Companies doing buybacks often see positive abnormal returns. Mergers and acquisitions? Target companies usually win with abnormal returns. But global trade tensions are kind of messing with M&A patterns everywhere.