Understanding the Concept and Its Importance in Investing
When it comes to investing, the goal is often to earn a profit above and beyond what is expected. This excess profit is known as abnormal return.
But what exactly is abnormal return and how can it be calculated?
Definition of Abnormal Return
Abnormal return refers to the excess profit earned from an investment above the expected return. It is the difference between the actual return on an investment and the expected return, which is determined by the overall performance of the market.
For example, let’s say the stock market is expected to return 8% per year. If an investor earns a return of 12% on their investment, their abnormal return would be 4%.
Calculating Abnormal Return
To calculate abnormal return, you’ll need to use the following formula:
Abnormal Return = Actual Return – Expected Return
It’s important to note that the expected return is not the same as the average return. It is based on the overall performance of the market and the specific risk level of the investment.
Importance of Abnormal Return
Abnormal return is important for investors because it allows them to measure the performance of their investments relative to the market. If an investment is earning an abnormal return, it means it is outperforming the market.
On the other hand, if an investment is earning a negative abnormal return, it means it is underperforming the market. This can help investors identify areas where they may need to reevaluate their investment strategy.
Abnormal Return is the Excessive Return
In summary, abnormal return is the excess profit earned from an investment above the expected return. It is calculated by subtracting the expected return from the actual return and is an important measure of an investment’s performance relative to the market.