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©All rights reserved to prof. Rafi Eldor

1

THE IMPACT OF TERRORISM

AND ANTI-TERRORISM ON

CAPITAL MARKETS

Rafi Eldor

Shmuel Hauser*

Rafi Melnick

*Ben-Gurion University, Israel


2

Background

• In the aftermath of terror attacks, the

impact on financial markets is widely

discussed

• When information about terror attacks

becomes available, individual stocks

respond to reflect investors hopes and fears

about the future


3

Background

• In other words, asset values respond to changes in

expected profitability

• The potential immediate response is due to the

liquidity of the stock market that allows the

decisions to buy and sell to be reversed in a quickly,

easily, and inexpensively manner

• As a result, Stock prices are natural informative

measure of the impact of terrorism on the economy


4

Background

• Yet, households, firms and governments may exhibit different preferences following terror attacks when they re-assess their vulnerability to terrorism as reflected in increased direct and indirect costs

• For example, investors may flee the market (sell their shares) in search for safer financial instruments


5

Background

• In such cases, terror attacks may have

the potential to turn initial panic into

chaos and a long-term bear market.

• Alternatively, the initial panic can be

reversed if investors’ hopes return or if

there is an effective anti-terrorism

policy.


6

Background

• An efficient stock market reflects the way economy absorbs exogenous and endogenous shocks such as terror attacks.

• For our purposes:

(-) Transitory effect means overreaction and correction

(-) Permanent effect means no overreaction


7

Background

Real economic activity and Share Prices during the Intifada in comparison

with other periods

Annual Rate of Change in

GDP

Annual Change in

Stock Prices

Period

4.62% 8.73% All Period: 1/1990-3/2005

5.99% 10.24% 9/2000-1/1990

-0.5% 1.02% Intifada: 10/2000-12/2003

5.82% %18.58 3/2005-1/2004


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Background

General Stock Index and General Index of Economic Activity

0.0000

50.0000

100.0000

150.0000

200.0000

250.0000

300.0000

350.0000

400.0000

89 92 95 98 00 03 06

Stock Index Growth


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Data Table 2

Number of

People Injured

Number of

People Killed

No. of Terror

Attacks

3,916 837 460 Total Terror Attacks

Sample – Terror Events

3,916 837 280 Total

1,245 168 47 Total number of events

inside trading hours Period

2,433 443 151 4/2001-9/2000 1,483 394 129 12/2003-5/2002

Location of the attack

3,609 599 110 Inside the Green Line 307 238 170 Outside the Green Line

Type of Attack

915 360 74 Suicide 3,001 477 206 Other


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Methodology

(-) We use an event study analysis

(-) We estimate stock returns based on TA-

25 index

(-) We investigate terror attacks during

trading hours and outside of trading

hours. We use 30 seconds returns


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Methodology

Pessimism or Terror Index (TI) as follows:

TI = D1 + D2 + D3 + D4 + D5

where:

D1 = 0 if the attack was beyond the Green Line and 1 if it was within the Green

Line;

D2 = 0 if the attack was not a suicide attack and 1 if it was;

D3 = 0 if there were no deaths and 1 if there were;

D4 = 0 if there were no injured and 1 if there were;

D5 = 0 if the event was not reported on a newspaper's front page and 1 if it was.


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Methodology

• We test the effect of terror attacks on stock and bond markets

• We test the tradeoff between these markets

• We test the effect of anti-terrorism policy on these markets; Anti-terrorism is proxied by targeted killings

• We test whether these effects are permanent or transitory.


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Main Results

During Trading Hours

-0.0045

-0.004

-0.0035

-0.003

-0.0025

-0.002

-0.0015

-0.001

-0.0005

0

0.0005

-80 -60 -40 -20 0 20 40 60 80 100 120 140

Minutes from Incident

Av

era

ge

Cu

mu

lati

ve

Ra

te o

f R

etu

rn


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Main Results - Volatility

Figure 2: Volatility during Trading Hours

Inside Trading Hours

0

0.0001

0.0002

0.0003

0.0004

0.0005

0.0006

-80 -60 -40 -20 0 20 40 60 80 100 120 140

Minutes from Incident

Av

era

ge

SD

of

RR


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Main Results

Table 3

Effect of Terror Attacks on Stock Prices - CR (%)

Standard Deviation Median Average

Panel A – Partial sample: 47 terror attacks that occurred during the trading day

0.683 0.453- 0.360- CR(-60,60)

(0.000) (0.000) 0.375 0.028 0.031 CR(61,120)

(0.548) (0.580)

Panel B – Entire sample: 280 terror events

2.165 0.301- 0.269- CR(-1,0) (0.049) (0.038)

1.367 0.243 0.147- CR(0,1) (0.030) (0.074)

1.058 0.187- 0.140- CR(0,Open) (0.027) (0.057)

2.534 0.453- 0.416- CR(-1,1) (0.003) (0.006)

1.544 0.162- 0.082 CR(1,2) (0.346) (0.380)


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Main Results

Table 4

Effect of Attack’s Severity on Stock Prices

Intra-day Sample

CR(-60,60)

Entire Sample

CR(-1,1)

Average

(%) N Average

( %) N

0.458- 31 0.705- 163 High Pessimism Index (TI) 0.171- 16 0.013- 117 Low

(0.015) (0.012) p-vlaue

0.461- 23 0.543- 151 4/2001-9/2000 Period 0.264- 24 0.267- 129 12/2003-5/2001

(0.059) (0.182) p-vlaue

0.443- 38 0.634- 206 Front page Newspaper coverage 0.011- 9 0.106- 74 Other

(0.003) (0.093) p-vlaue


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Main Results

Table 5

Effect of Terrorist Attacks on Bond Prices

CR(-1,1) - %

Long-term

Bond Short-term

Bonds All Government

Bonds

0.012- 0.065 0.041 Average

(0.750) (0.000) (0.060) P-Value


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Main Results

Table 6

Effect of Targeted Killings on the Stock and Bond Markets

Stocks All Bonds Short-term

Bonds Long-term

Bonds Days on which there were

no targeted killings

0.045- 0.071 0.084 0.067

Days on which there were

targeted killings

0.032- 0.005- 0.011 0.007-

p-value (0.347) (0.007) (0.013) (0.191)


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Main Results

Table 7

Do terror attacks have a permanent effect on the stock and bond markets?

ttttttt YTITITIUSRY 132211010 _

ttt govtRTARY _,_ -Rates of return general stock and bond indices;

R_US - Rates of the index of stocks traded in the US stock market;

TI - Terrorism index;

1tY Rate of return on day t-1;

0210 - The effect of terror attacks is permanent;

02 - The effect is permanent but also characterized by overshooting with mild

corrections.

Dependent Parameter Yt= CR(-1,1)

Bonds Yield Stocks Yield Regression Coefficients

0.00099 0.00488 0

(0.002) (0.168)

0.0043- 0.16100 1

(0.105) (0.055)

0.00021- 0.00247- 0

(0.066) (0.032)

0.00006 0.00021- 1

(0.949) (0.840)

0.00019- 0.00026 2

(0.122) (0.807)

1.65277 1.03673 1tY (0.000) (0.000)

0.00039- 0.00293- 210

(0.089) (0.058)

0.549 0.341 2R

(0.000) (0.000)


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Main Results

1. On average, stock prices fall by 0.4% following a terror attack

2. Outside of trading hours, stock prices fall within the first few minutes of trading

3. Similarly, during trading hours, stock prices fall within the first hour of trading


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Main Results

4. We find that the stock market responds efficiently – we don’t find evidence that there is an initial panic that turns into chaos.

5. On average, there is no overreaction and correction.

6. It appears that this result did not change significantly over time

7. The results are not different whether the market is trending up or down prior to the terror attack


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Main Results

8. Stock prices fall more dramatically

when:

(-) Terror attack in green line

(-) It is a suicide attack

(-) The more casualties there are

(-) Terror attack is covered in 1st page

of newspaper


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Conclusions

9. The fall of stock prices is permanent

in the sense that:

(-) We find no evidence that there is

overreaction followed by correction

10. Anti-terrorism has insignificant effect on

investors’ expectations


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Main Results

11. Investors tend to shift their investment

towards short-term non-risky investments

12. It appears that this result did not change

significantly over time

13. Over the 4 years of Intifada, the

accumulated damage of terror

attacks – costs of terror – is

estimated by over 20%


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Thank You

……

Marketing

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