ECON 4415 April 22, 2013 Terrorism and the Stock Market By G.

Andrew Karolyi and Rodolfo Martell

Tanveer Singh Chandok

This paper examines the stock price impact of terrorist activities. Using the Counterterrorism Office of the U.S. Department of State, 75 attacks between 1995 and 2002 were identified. The stock prices on the day of these attacks, and the following days were examined. Significant losses were identified. This paper looks at specific terrorist activities against an industry or specific companies. The spillover effects of these terrorist activities are also examined. This paper is focused on the long term effects of terrorist activities. An apt quote at the beginning of the paper reads as follows: "The terrorists want to attack our country and harm our citizens. They believe that the world's democracies are weak, and that by killing innocent civilians they can break our will. They're mistaken. America will not retreat in the face of terrorists and murderers. And neither will the free world. We will not yield. We will defend our freedom." - President George W. Bush, FBI Academy, Quantico, Virginia, July 11, 2005. The terrorist attack on September 11th, 2011 shook the United States and the free world. The number of casualties and the ensuing damage was unprecedented. The collateral damage extended well beyond personal life and property; there was a large spillover of damage into financial markets, industry and the economy. Examining the data between 1995 and 2002, the authors found that there was a statistically significant negative stock price reaction on the day of a terrorist attack of -0.83%. This translates to an average loss of $401 million in firm market capitalization. The stock price reactions were not reversed within the window of analysis and were unique to the target firm in that there was no measurable spillover impact to the stocks of the firms industry peers. A cross-sectional analysis of the abnormal returns indicated that the impact of terrorist attacks differs according to the country in which the incident occurred. Attacks in countries that are wealthier and more democratic are associated with larger negative share price reactions. The authors compared the effects of human losses to property/physical losses and found (interestingly enough) that human losses (such as kidnappings of company executives) were associated with higher negative stock price movements. Physical losses were defined as bombings of facilities or buildings. The paper used the following hypothesis to reach the conclusions detailed above:

ECON 4415 April 22, 2013

Tanveer Singh Chandok

1. Firms that are targets of a terrorist act will experience a negative abnormal return around the date of the attack 2. Firms that are affected by a terrorist attack that involves only human capital (e.g. kidnapping) will experience a negative abnormal return around the date of the attack 3. Firms domiciled in richer, more democratic and better educated countries will experience larger negative returns following an attack than firms located in poorer, less educated and less democratic countries All three of the hypothesis detailed above were proved true by the authors data set examination. The authors ultimately discuss TRIA (a backstop provision of up to $100 billion zero-cost reinsurance for terrorist events) and its failure to provide for any long-term scheme for terrorism insurance. Quoting the authors, America cannot risk a gamble on terror insurance, renewal of TRIA is critical as a private insurance market will never developcatastrophic terrorism is uninsurable by the private market because its true dimensions are incalculable, whether you live in London, Madrid or New York.