Answer Happy

You have estimated the historical relationship between
stock ITT’s return and market return using a single-index
model with daily return data:
r = 0.1% + 1.5rM
On the announcement date (t=0) of ITT’s earnings, its
return was 5.5% while the market return was 2%. Your assistant has
worked out the remaining abnormal returns (AR) for ITT surrounding
the announcement date (t=0).
Required:
(1) Calculate the abnormal return for ITT on t=0. Does the
market perceive the earnings announcement as good news? [4
marks]
(2) Calculate cumulative abnormal return CAR from t=1 to
t=5. Does CAR[1, 5] violate the semi-strong form of market
efficiency? Explain. [4 marks]
(3) Does CAR[-3, -1] violate the semi-strong form of
market efficiency? Explain. [3 marks]
(4) If you believe the above pattern of abnormal returns
is caused by market inefficiency, how would you design a trading
strategy to exploit the inefficiency? [3 marks]
(5) Discuss how Prospect Theory may help explain why
momentum strategy works?
t = -3 -2 -1 0 2 3 4 5 1 1.2% AR = 2.2% 1.8% 2.5% ? 2.1% 2.2% 3.5% 2.8%