The impact of terrorism on financial markets

Research in the Department of Finance has examined the nine major bombings since 1998 that have been attributed to Al Qaida to examine market efficiency, including a test of rumours that investors traded with advance knowledge of attacks.

Acts of terrorism not only devastate lives but seek to rupture economies and the financial infrastructure that underpins them. Understanding the impact these acts of terrorism have had on financial markets structures is important to examine the efficiency of these markets.

‘Terrorist attacks provide a unique opportunity to calibrate the time taken for markets to react to release of unexpected price-sensitive information’ outlined Dr Les Coleman, author of the research.

‘Markets that are strongly efficient do not offer investors the opportunity to trade profitably using monopoly inside information. Therefore this analysis of market efficiency conducts two tests, how long is required for markets to fully impound the price impact of terrorist attacks, and have investors with advance knowledge of the attacks traded profitably around them’

Dr Coleman’s examined the nine major terrorist attacks by Al Qaida that were outlined in a 2005 list by UK Prime Minister Blair and analysed market reaction around the attacks by using minute-by-minute tick data while also conducting event studies with daily data.

‘The innovations of this research is the list of terrorist attacks avoids subjectivity and biases inherent in previous studies of financial consequences of terrorist attacks, while the approach to market reaction provides granular analysis along the entire event timeline’ highlighted Dr Coleman.

The nine attacks examined were roughly evenly spaced through the 1998-2005 period with a t least one in each calendar year expect 1999. They were geographically spread across Africa (three), Asia (three), Europe (two) and USA (one).

The dates of the attacks were clustered with seven of the nine attacks occurring between May and October and most of the attacks occurred during the morning.  Dr Coleman’s examination of these attacks and analysis of the market data has provided powerful insights.

Only four bombings moved a major stock market by more than 1% within 90 minutes of their occurrence, on the four occasions when this occurred the first market reaction occurred within 20-40 minutes and was largely completed within another hour. ‘This suggests that markets are very efficient in quantifying the financial impacts of terrorists  events, and matches other evidence that markets take well under a trading day to price in completely unanticipated impacts’ explained Dr Coleman.

Another major finding of this research was that the times of the attacks were not consistent with optimised insider trading. ‘The timings of the bombings were not particularly advantageous for insiders as they occurred either too early in the day when it would have been hard to surreptitiously close out positions after the attack.

Thus insiders would be forced to hold positions overnight which increase the risk of confounding events arising and eroding the trading value of their monopoly knowledge’ highlighted Dr Coleman.

This study reaffirms the semi-strong and strong efficiency of markets. In brief it showed that major markets such as Hong Kong, London and Tokyo, take less than half a trading session to fully price in the impacts of totally unexpected terrorist attacks no matter their location.

Moreover this study confirmed that there is no conclusive evidence to support rumours that investors associated with Al Qaida have traded profitably ahead of any of their major attacks.

‘The literature on the financial effects of terrorist attacks is still fragmented, but is tentative conclusions are confirmed here. Most terrorist attacks have minimal, transient impacts on financial markets’ concluded Dr Coleman.

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