Terrorism and Market Jitters

A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Kollias, Christos; Papadamou, Stephanos Research Report Terrorism and Market Jitters EUSECON Policy Briefing, No. 21 Provided in Cooperation with: German Institute for Economic Research (DIW Berlin) Suggested Citation: Kollias, Christos; Papadamou, Stephanos (2012) : Terrorism and Market Jitters, EUSECON Policy Briefing, No. 21, Deutsches Institut für Wirtschaftsforschung (DIW), Berlin This Version is available at: http://hdl.handle.net/10419/119602 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. 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These costs are not limited to the © Shotshop often very large amounts of resources required to What is the reaction of European provide protection against terrorism or to the markets to terrorist events? immediate damages, loss of property and stock of capital a terrorist attack causes. A number of economic What influences reaction? sectors and activities including growth and Is there a contagion potential? investment; FDI flows; the tourist industry; stock How important are size, maturity markets can be adversely affected by terrorist actions and target attributes? as the empirical findings of a plethora of studies have shown (see for instance Brück and Wickstrom, 2004; Enders and Sandler, 2006). Equity and capital markets Summary: are also susceptible to incur losses as a result of terrorist activity. From the stock markets perspective Terrorist actions can have a multitude of economic terrorist incidents represent exogenous shocks just as consequences that may adversely affect a number of anthropogenic catastrophes and accidents, political economic indices, sectors and activities including risk and violent events such as conflict do. Although growth and investment. From the markets’ the threat of a terrorist attack is omnipresent, perspective, terrorist attacks are unforeseen events particularly in countries that are or have in the past that, depending among other things on their been the victims of systematic and continuous terror magnitude, the number of casualties, the extent of the campaigns (for instance Spain and the UK in the case damages, the targets hit; shake and rattle them. Such of European countries), terrorist events when they incidents can also have a high contagion potential occur are unforeseen and, depending among others on with the shock waves travelling quickly from one their magnitude in terms of victims and/or damages market to another. Nevertheless, the negative impact caused or target(s) hit, have the potential to shake and on markets from terrorist attacks is, in comparative rattle markets and investors. Just as in the case of terms, mild and short-lived. natural or anthropogenic catastrophes and industrial accidents, terrorist attacks are unanticipated and planned and executed as a means to protest against hence market agents cannot hedge against them. British involvement in the Iraq War and other conflicts. The bombings killed 52 commuters (as well European market reaction as the four suicide bombers), injured 700, and caused Most European countries have been the victims of a widespread disruption of the city's transport system terrorist attacks either from domestic or transnational and the country's mobile telecommunications terrorist organizations. Indeed, some European infrastructure. In both markets a strong negative countries, such as for instance Spain and the UK, have reaction was recorded on the day of the events. been the venue of systematic and continuous terror However, a significantly different recovery from the campaigns, and have been the victims of recent mega- initial negative reaction to the two incidents was the terrorist events that have taken place on the European case. In terms of days needed for the markets to continent and have captured world-wide attention rebound the London Stock Exchange recovered in a because of their magnitude. The 11th March 2004 in single trading day whereas the Stock Market in Madrid Madrid and 7th July 2005 in London terrorist attacks, took slightly longer (Kollias et al. 2011b). are in many respects regarded as the European equivalents of 9/11 albeit on a much lower scale if the number of fatalities and injuries is considered. The two attacks shared some common characteristics. The bombings targeted the transport system of the respective capitals of Spain and the UK and they were the work of Islamic extremists. “Homegrown” in the case of the London attacks, since the perpetrators were British citizens. As in the case of most terrorist attacks, the preferred venue by terrorist organizations are large urban centers since they offer a target rich Figure 1: London and Madrid general indices before and environment and also maximize the impact in terms of after the terrorist attacks. Source: Kollias et al. (2011b) damages and victims, hence wider publicity is Tentative explanations for this recorded recovery th guaranteed. The 11 March 2004 Madrid train difference between the London and Madrid stock terrorist actions consisted of a series of coordinated markets include differences in size, maturity and bombings against the Cercanías (commuter train) liquidity. Perhaps just as important was the fact that system of Madrid. The attacks caused the death of 191 the terrorist cell responsible for the bombings in people while another 1,755 suffered injuries. The Madrid was neutralized a few days later thus, in a direct costs were estimated to be around €212 million sense, it continued to present a potential security to the regional economy of Madrid, equivalent to the threat for a short period of time. This may have 0.16% of the region’s GDP. The Spanish terrorist group prolonged any negative effects on investors’ sentiment ETA was initially held responsible but soon afterwards and hence affected market performance. The initial Terrorist incidents exert a negative but confusion over the perpetrators of the attacks probably has also contributed to the short-lived impact on markets and equity uncertainty and the market jitters that the returns coordinated attacks created. Furthermore, it became apparent that the bomb attacks were the different and perhaps more effective institutional work of Islamic extremists. The 7th July 2005 London arrangements may also be cited. For instance, on July attacks also were a series of coordinated bomb blasts 9, two days after the event, the Bank of England, HM that hit London's public transport system during the Treasury and the Financial Services Authority morning rush hour. They were carried out by British revealed that, immediately after the attacks, they had Islamist extremists. The suicide bombings were instigated contingency plans (created after 9/11 for 2 | EUSECON POLICY BRIEFING 21 APRIL 2012 such an eventuality) to ensure that the UK financial A terrorist induced financial market contagion markets could keep trading. This suggests that the example is the case of the aforementioned 7th July existence of mechanisms and procedures that can be 2005 London attacks. The London Stock Exchange is set into motion in cases of emergencies and one of the major financial markets globally and the unanticipated events that have the potential to shake bigger in terms of market capitalization in Europe and unsettle markets, can help absorb part of the closely followed by the German and French markets. shock through measures that at least partly offset the Hence, the terrorist caused financial shock waves, initial impact on market sentiment and volatility. albeit short-lived as already seen, had the potential to Nevertheless, broadly speaking, despite the initial affect other major European markets given that the negative reaction, the dominant conclusion is that the degree of integration between European markets is overall net impact on the stock markets in both cases such that allows for the quick transmission of volatility was short-lived and transitory. This in fact, is the and negative sentiment. Indeed, this has been found to general conclusion reached by most studies that have be the case following the attacks in London.

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