Abstract
Tests for abnormal returns which are derived under the assumption of cross sectional independence are invalid if the abnormal returns are cross sectionally correlated. We model the cross sectional correlation by a spatial autoregressive model. The abnormal returns of firms belonging to the same group according to their business activities are correlated, whereas the abnormal returns of firms belonging to different groups are uncorrelated. Tests for abnormal returns corrected for cross sectional correlation are derived. An empirical application to US stock returns around Bear Stearns’collapse and Lehman Brothers’bankruptcy in 2008 is provided as an illustration. (JEL C21, C22, G12).
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