The Effects of Terrorism on Global Capital Markets (PDF Download ...

European Journal of Political Economy Vol. 20 (2004) 349 – 366 www.elsevier.com/locate/econbase

The effects of terrorism on global capital markets Andrew H. Chen a, Thomas F. Siems b,* a

Cox School of Business, Southern Methodist University, Dallas, TX 75275, USA b Federal Reserve Bank of Dallas, Dallas, TX 75201, USA

Received 3 June 2002; received in revised form 21 July 2003; accepted 4 August 2003 Available online 8 March 2004

Abstract The event study methodology is used to assess the effects of terrorism on global capital markets. We examine the U.S. capital market’s response to 14 terrorist/military attacks dating back to 1915 and global capital markets’ response to two recent events—Iraq’s invasion of Kuwait in 1990 and the September 11, 2001 terrorist attacks. U.S. capital markets are more resilient than in the past and recover sooner from terrorist attacks than other global capital markets. Evidence suggests that this increased market resilience can be partially explained by a stable banking/financial sector that provides adequate liquidity to promote market stability and minimize panic. D 2004 Elsevier B.V. All rights reserved. JEL classification: G14; G15; G18 Keywords: Global capital markets; Terrorism; Event study methodology; Efficient markets hypothesis; Market resilience

1. Introduction Prices of individual stocks reflect investors’ hopes and fears about the future, and taken in aggregate, stock price movements can generate a tidal wave of activity. Because of their liquidity, terrorist attacks, military invasions and other unforeseen disastrous occurrences can have serious implications for stocks and bonds. Decisions to buy and sell can quickly, easily, and inexpensively, be reversed. When information becomes available about a cataclysmic event—like a terrorist or military attack—investors often flee the market in search of safer financial instruments and panic selling ensues. This initial panic has the potential to turn into chaos and a long-term bear market, or it can be reversed if investors’ hopes return. * Corresponding author. Tel.: +1-214-922-5129. E-mail address: [email protected] (T.F. Siems). 0176-2680/$ - see front matter D 2004 Elsevier B.V. All rights reserved. doi:10.1016/j.ejpoleco.2003.12.005

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A.H. Chen, T.F. Siems / European Journal of Political Economy Vol. 20 (2004) 349–366

In this paper, we investigate the response of global capital markets to terrorist and military attacks. We first examine the U.S. capital market’s response to terrorist attacks, including government initiated invasions of other countries, dating back to the sinking of the luxury ocean liner Lusitania by a torpedo in 1915. We then investigate the reaction of several global capital markets to the two recent events with the greatest negative impact on U.S. capital markets: Iraq’s invasion of Kuwait in 1990 and the September 11, 2001 terrorist attacks against the United States. We conclude that terrorist attacks and military invasions have great potential to effect capital markets around the world in a short period of time. In today’s information-oriented world, news travels very fast and contagion can spread quickly. We find evidence, however, that U.S. capital markets seem to have become more resilient and are better able to absorb shocks brought on by such events. We also find evidence that an economy’s banking/ financial sector seems to be an important force in returning markets to relative stability. Finally, to increase market stability, policymakers and regulators around the world should be aware of these strong forces and the inter-relatedness in global capital markets and, thus, proactively share information in a timely manner in a move toward greater global cooperation and communication.

2. Research questions Within the event study methodology, we can test a number of hypotheses. First, we examine the U.S. capital market’s response to a selection of historical terrorist and military attacks. This is essentially the standard event-study test to determine whether the capital market experienced significant abnormal returns in response to any of the past events. Then, we include available market data from actively traded stock exchanges from around the world to examine the global capital markets’ reactions to terrorist and military attacks that occurred in the recent past. In addition, where data are available, we also test the significance of abnormal returns in each market’s banking/ financial sector. Research Question 1: Are historical terrorist and military attacks associated with significant negative abnormal returns in U.S. capital markets? And, if so, to what relative degree? It appears obvious that a terrorist or military attack would likely have a negative effect on capital markets. Uncertainty about what the future holds and about individual firm’s abilities and the resources needed to see them through a crisis often clouds judgment, sending many investors into a panic. Moreover, terrorist and military attacks often increase basic costs of doing business as security is enhanced and shipping times lengthened. We identify several historic terrorist attacks and military invasions and compare the depths and statistical significance of the negative returns across the various events. Which events resulted in the most negative returns? For which events did the markets seem to rebound the quickest? Research Question 2: Are recent terrorist and military attacks associated with significant negative abnormal returns in global capital markets?


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Again, for reasons cited above, we expect significant negative abnormal returns in global capital markets at, and following, terrorist and military attacks. But which markets reacted more negatively (or more positively) than others, and why? Which events resulted in prolonged negative returns? Which events impacted global capital markets more than U.S. capital markets, and vice versa? Research Question 3: Can the banking/financial sector help minimize crises in capital markets resulting from terrorist and military attacks? Strong economies rely upon strong banking/financial sectors, which are in turn influenced by effective and appropriate monetary policies. In times of crises, it may be necessary for policymakers to add a degree of flexibility in order to provide adequate liquidity to a shaky and panicky market. In most cases, we expect the banking/financial sector to respond to news of a terrorist or military attack by generating significant negative returns. But if the outlook improves rapidly in this sectorUperhaps because the nation’s monetary authority quickly provided adequate liquidityUthen we expect the associated capital market to also quickly improve.

3. Methodology The event-study methodology is a forward-looking approach that focuses on identifying abnormal returns to firms from a specific event. If investors react favorably to an event, we would expect positive abnormal stock returns around the event date. Alternatively, if investors react unfavorably to an event, we would expect negative abnormal stock returns. Hence, when analyzed using composite stock indices (or major sector indices), abnormal returns provide a means of assessing the capital market’s (or sector’s) response to specific events. The event-study methodology is based on the efficient markets hypothesis (Fama et al., 1969). This hypothesis generally states that as new information becomes available (perhaps as the result of some significant unexpected event), it is fully taken into consideration by investors assessing its current and future impact. Investors immediately reassess individual firms and their ability to withstand potential economic, environmental, political, societal, and demographic changes resulting from the event. The new assessment results in stock price changes that reflect the discounted value of current and future firm performance. Significant positive or negative stock price changes can then be attributed to specific events. The strength of the eventstudy method lies in its ability to identify such abnormal changes because it is based on the overall assessment of many investors who quickly process all available information in assessing each individual firm’s market value (Schwert, 1981). For example, Abadie and Gardeazabal (2003) use the event study methodology to examine the economic impact on firms from terrorist conflicts in the Basque Country, Spain. They find that stocks of firms with a significant part of their business in the Basque Country showed a positive relative performance when truce became credible, and a negative relative performance at the end of the cease-fire.

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Because we examine world stock market indices as a portfolio of individual stocks, we follow the excess returns approach as described by Brown and Warner (1985) to measure a market’s (or major market sector’s) abnormal performance. This methodology allows us to statistically test the significance of the economic impact of an event on world capital markets as measured by the deviation of index returns from their average. In other words, how different (in size and duration) are the returns from past averages? Since index returns are random variables, they will deviate from their means over any given event window. Also, when examining these deviations to past average returns and taking into account historical variability, we can draw important conclusions regarding the statistical significance (the depth and breadth) of an event. If the return deviation (abnormal return) is small and statistically insignificant on trading days that coincide with an event, then we can conclude that the market saw the event as inconsequential. However, if the return deviation is large and statistically significant (falling outside the range of returns normally expected), then we can conclude that the market saw the event as important and one that moved it significantly.1 Daily excess returns were measured by the mean-adjusted-returns approach; that is, for each day at, and following, the event, we computed ARjt ¼ Rjt R¯ j ;

ð1Þ

where ARjt is the abnormal (or excess) return for stock index j at time t, Rjt is the actual observed rate of return for stock index j at time t, and R¯j is the mean of stock index j’s daily returns in the ( 30, 11) estimation period. R¯j is computed as follows: 11 1 X R¯ j ¼ Rjt : 20 t¼30

ð2Þ

The date of the event is t = 0, the mean adjusted returns model is estimated over 20 days, from t = 30 to t = 11 relative to the event date. The main event window under study is the event date itself (t = 0). However, we also examine two longer event windows to see how well and how quickly the market digested the news. Sometimes, the initial uncertainties persist and that keeps stock prices down and volatile, but at other times these fears are reduced because of new information that eases market tensions or policy actions that promote greater market stability. The two longer event windows are from the event date to 5 days following the event (t= + 5) and from the event date to 10 days following the event (t= + 10). For these longer event windows, we also compute the cumulative average abnormal returns (CARs). The statistical significance of the event period abnormal returns was computed for each sample using the test statistics described by Brown and Warner (1985). 1 For most trading days, the deviation of the market index return from its past average is fairly small and insignificant. However, for some trading days, the deviation (abnormal return) can be large and significant. When large deviations occur, there is typically an underlying reason. Our study examines events where there is some selection bias. As a result, we may have included some events that had no significant impact on the market and excluded others that had a significant impact. Nevertheless, for the selected events, we can use standard event study analysis to examine the size and duration of market responses.


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4. A historical perspective on past terrorist attacks and military invasions on U.S. capital markets In this section of the paper, we examine several terrorist attacks and military invasions that rocked U.S. capital markets. While our list is subjectively determined, we selected terrorist attacks from the Significant Terrorist Incidents list published by the U.S. Department of State (2001) as well as a list from the Constitutional Rights Foundation (2001). We also included significant military attacks that seemed to have an element of surprise and resulted in war. For continuity, the events are examined chronologically. We use the Dow Jones Industrial Average (DJIA or Dow) as our market index because of its availability, usefulness and widespread visibility among market participants. There have been a number of past terrorist and military attacks that have resulted in extreme stock price volatility as anxious investors sell to exhaust their panic while buyers remain on the sidelines until they build up enough courage to reenter the market. Table 1 lists each event, its abnormal returns over three different event periods, and the number of trading days until the DJIA index returned to its pre-attack level. To indicate whether the index returns deviate from their means by more than one would expect through normal variation, the table includes t-statistics as an indication of how significant each event was. The t-statistics essentially test the significance of the economic impact of an event on the capital market as measured by the deviation of index returns from their average. If the event had no consequence, one would expect an insignificant return deviation. This logic holds for cumulative returns as well as returns on individual days. Also included in the table are the t-statistics and an indication of whether the abnormal returns are statistically different from zero. To see a long-term perspective of the Dow, Fig. 1 plots the index on the natural log scale. Each event listed in Table 1 is highlighted in Fig. 1 by a vertical line, as well as two additional endogenous events of interest not included in this study: the 1929 stock market crash and the 1987 stock market crash. Overall, the DJIA index has risen an average 5.88% per year from the beginning of 1915 through 2002. Of the 14 terrorist/military attacks listed in Table 1, 12 events experienced negative abnormal returns (ARs) on the day of the event.2 The only events with positive event-day ARs were the bombing of the Alfred P. Murrah Federal Building in Oklahoma City on April 19, 1995 and the Embassy bombing in Kenya on August 7, 1998. Six events—including the first five events on our list—had negative ARs that were significantly different from zero at the 0.01 level, one event had a significant negative AR at the 0.05 level, and one event had a significant negative AR at the 0.10 level. While the event-day ARs are interesting in that they show immediate investor reaction to terrorist and unexpected military attacks, the cumulative average abnormal returns (6- and 11-day CARs) provide a stronger indication of the capital market’s resilience and ability (or inability) to bounce back from the attacks. Of the 14 events listed in Table 1, 11 experienced

2 For the September 11, 2001 terrorist attacks, the event date was when U.S. capital markets reopened on September 17, 2001.

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Table 1 Average abnormal returns on the Dow Jones Industrial Average stock index following terrorist attacks Terrorist/Military attack

Event date

Event-day AR

6-day CAR

11-day CAR

Lusitania Torpedoed

7 May 1915

Invasion of France

12 May 1940

Pearl Harbor Attack

7 December 1941 25 June 1950

5.26%*** ( 4.24) 4.93%*** ( 8.69) 2.75%*** ( 3.78) 4.82%*** ( 11.00) 2.65%*** ( 3.87) 0.12% ( 0.16) 0.49%* ( 0.90) 3.34% ( 0.52) 0.13% ( 0.14) 1.35%** ( 1.82) 0.06% ( 0.10) 0.47% (0.92) 0.23% (0.27) 7.14%*** ( 7.72)

16.08%*** ( 5.04) 16.22%*** ( 11.12) 3.09% ( 1.65) 8.30%*** ( 7.36) 3.53% ( 2.00) 2.69% ( 1.36) 0.34% ( 0.24) 0.95% ( 0.06) 0.39% (0.17) 5.79%* ( 3.04) 0.17% ( 0.12) 1.59% (1.22) 1.83% ( 0.83) 10.57%** ( 4.45)

12.30%* ( 2.85) 21.02%*** ( 10.65) 6.42% ( 2.53) 11.03%*** ( 7.23) 4.78% ( 2.00) 4.19% ( 1.56) 2.58% ( 1.36) 9.10% (0.41) 0.63% (0.20) 9.35%* ( 3.63) 0.59% ( 0.31) 2.24% (1.27) 0.55% ( 0.19) 7.90% ( 2.45)

North Korea Attacks South Korea Kent State Shootings Beirut Bombing Air India Bombing Korean Air Bombing Pan Am Bombing Iraq Invades Kuwait World Trade Center Bombing Oklahoma City Bombing Embassy Bombing in Kenya September 11th Terrorist Attacks

4 May 1970 23 October 1983 21 June 1985 30 November 1987 21 December 1988 2 August 1990 26 February 1993 19 April 1995 7 August 1998 11 September 2001

Days to rebounda 21 795 232 57 54 1 4 11 3 134 1 1 1 40

Standard errors are in parentheses. a Number of trading days for the market index to return to pre-attack level. * Statistically significant at the 0.10 level. ** Statistically significant at the 0.05 level. *** Statistically significant at the 0.01 level.

negative 6- and 11-day CARs. Positive CARs resulted after the Oklahoma City bombing, the Korean Air bombing in November 1987, and the Pan Am bombing over Lockerbie, Scotland in December 1988. Three events experienced significant negative CARs at the 0.01 level over the 6-day event window, and two of these three events saw significant negative CARs persist over the 11-day horizon. The three events with significant 6-day negative CARs include the sinking of the luxury cruise ship Lusitania by a torpedo on May 7, 1915, Hitler’s invasion into France on May 12, 1940, and the attack on South Korea by the North Korean People’s Army on June 25, 1950. It is worth noting that for all three events, the CARs for the 11-day event window were all double-digit negative CARs. During this time window, new information continued to have a negative effect on stock prices. Also note that the only other event with a statistically significant negative CAR over both of these two event

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Fig. 1. Dow Jones industrial average 1915-2002.


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horizons was Iraq’s invasion of Kuwait on August 2, 1990 (both event windows were significant at the 0.10 level). The only other attack with a statistically significant negative CAR over one of the two longer event horizons occurred after U.S. capital markets reopened following the terrorist attacks against the United States on September 11, 2001. The 6-day CAR was 10.57%, significant at the 0.05 level, however, the 11-day CAR dropped to 7.90% and was not statistically different from zero. Fig. 2 summarizes the 11-day CARs and significance levels for these 14 events. The event CARs are arranged chronologically and indicate a trend toward greater capital market resilience. That is, the CARs generally become less negative and fewer events experienced negative CARs statistically different from zero. The last column of Table 1 shows that, over time, fewer trading days in general were required to return the DJIA index to its pre-attack level. Most notably, following Hitler’s invasion into France, the Dow remained down for 795 trading days, or about 2 1/2 years. After the surprise attack on Pearl Harbor, the Dow did not recover for another 232 trading days (about 1 year). The next major shock to have a fairly protracted negative impact on the Dow was Iraq’s invasion into Kuwait when the Dow did not fully rebound for 134 trading days (about 7 months). After September 11, 2001, the Dow recovered in 40 trading days (about 2 months) following the most horrific attacks on U.S. soil since the War of 1812. While it is certainly difficult to draw definitive conclusions when examining the abnormal returns from these events over time, there may be several reasons to explain this increased market resilience. First, improved technology has made communications and information acquisition and transmission more timely and accurate. This has also helped make markets more efficient, along with having more market participants. Additionally, more flexible and appropriate monetary and fiscal policies may have been better able to

Fig. 2. U.S. capital markets’ 11-day cumulative abnormal returns (Dow Jones industrial average index).


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assure markets and promote stability by providing proper levels of liquidity in times of need. Overall, an investigation of the abnormal returns following these 14 events indicates that U.S. capital markets today appear to be more resilient and are quicker to absorb news of terrorist attacks and military invasions. Increased capital market resilience seems to also be reflected by the fact that three of the first four events in our series experienced the largest negative 11-day CARs, all of which had significant negative CARs at the 0.10 level (with two of the three events significant at the 0.01 level). In contrast, only one terrorist/military attack in the last 60 years—Iraq’s invasion into Kuwait—had a significant negative 11-day CAR, and its significance level barely made the 0.10 cutoff. As horrific as the September 11th attacks were, with planned attacks against U.S. financial and military symbols, the capital markets managed to rebound rather quickly.

5. Global capital markets and recent terrorist/military attacks In this information age, news (especially bad news) spreads very rapidly around the world with quick spillover or contagion effects, making global capital markets today more tightly inter-linked. See, for example, evidence presented in recent studies by Arshanapalli and Doukas (1993) and Hamao et al. (1990). We now turn our attention to the reaction of global capital markets for two recent terrorist/military attacks—the September 11th terrorist attacks and Iraq’s invasion into Kuwait. These events were selected because they were the only recent events where the Dow experienced significant negative abnormal returns and resulted in stock prices remaining below pre-attack levels for 40 or more trading days. We begin with an analysis of the global capital markets’ reaction to the September 11th attacks and then consider the markets’ response to Iraq’s invasion of Kuwait. Global stock market data were obtained from Bloomberg. We used the broadest stock market indexes available in each market, comparable to the New York Stock Exchange (NYSE) composite index in the U.S. 5.1. September 11th terrorist attacks Table 2 shows the abnormal returns and statistical significance levels for the 4-, 6-, and 11-day event windows following the September 11th terrorist attacks for 33 capital markets (or major indices) located around the world.3 Also included in the table is a column showing the number of trading days before each global capital market returned to its preSeptember 11th level. All 33 global capital markets in our sample experienced significant negative ARs the day investors in those markets first learned of the September 11th terrorist attacks against the United States. Of the 33 capital markets, 31 (94%) had significant negative ARs at the 0.01 level, and 2 markets (Helsinki and Austria) declined at the 0.10 level. 3 The event date is September 11th for global capital markets open at the time of the attacks and September 12th for those closed when the attacks commenced. For the U.S. and Mexico capital markets, the event date is September 17th when the markets reopened.

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Table 2 Average abnormal returns on global capital markets, following the September 11th terrorist attacks Global stock market

Event-day AR

6-day CAR

11-day CAR

Days to rebounda

S&P 500 Dow Industrials NYSE Nasdaq Toronto Mexico London Frankfurt Europe-Bloomberg France Spain Switzerland Austria Italy Belgium Amsterdam Portugal Helsinki Norway Sweden Tokyo Hong Kong South Korea India Jakarta Singapore Kuala Lampur Australia New Zealand Pakistan Saudi Arabia Israel Johannesburg

4.84%*** ( 5.48) 7.14%*** ( 7.72) 4.55%*** ( 7.14) 6.56%*** ( 3.70) 4.05%*** ( 5.67) 5.45%*** ( 4.24) 5.29%*** ( 6.46) 7.61%*** ( 6.73) 6.23%*** ( 6.71) 7.07%*** ( 7.26) 4.79%*** ( 4.43) 7.03%*** ( 6.59) 0.96%* ( 1.54) 7.71%*** ( 9.45) 5.41%*** ( 10.54) 6.94%*** ( 7.83) 3.82%*** ( 5.75) 3.30%* ( 1.58) 4.53%*** ( 8.33) 7.65%*** ( 6.56) 6.20%*** ( 4.77) 8.45%*** ( 5.84) 12.42%*** ( 8.33) 5.45%*** ( 4.24) 3.42%*** ( 3.16) 4.69%*** ( 7.80) 4.46%*** ( 4.89) 4.19%***( 6.50) 4.50%*** ( 9.28) 3.94%*** ( 4.28) 4.10%*** ( 12.05) 1.82%*** ( 2.62) 2.66%*** ( 2.69)

7.72%* ( 3.40) 10.57%** ( 4.45) 8.09%** ( 4.93) 10.14% ( 2.22) 9.21%** ( 5.01) 13.17%* ( 3.98) 4.77% ( 2.27) 7.98% ( 2.75) 6.82% ( 2.86) 9.80%* ( 3.91) 7.64%* ( 2.75) 5.97% ( 2.17) 4.36% ( 2.70) 13.51%*** ( 6.44) 8.51%*** ( 6.44) 8.52%* ( 3.74) 6.70%* ( 3.91) 7.49% (1.40) 9.89%*** ( 7.08) 4.96% ( 1.65) 0.56% ( 0.17) 5.57% ( 1.50) 11.82%* ( 3.08) 13.17%* ( 3.98) 4.58% ( 1.65) 12.07%*** ( 7.80) 12.45%*** ( 5.31) 6.81%** ( 4.11) 6.66%*** ( 5.35) 11.73%*** ( 4.96) 8.19%*** ( 9.36) 11.27%*** ( 6.30) 11.40%*** ( 4.49)

3.83% ( 1.25) 7.90% ( 2.45) 3.98% ( 1.79) 9.99% ( 1.62) 9.87% ( 3.96) 6.54% ( 1.46) 9.04% ( 3.17) 10.64% ( 2.70) 8.30% ( 2.57) 10.82% ( 3.19) 8.83% ( 2.34) 7.29% ( 1.96) 7.76% ( 3.55) 14.19%* ( 5.00) 9.22%* ( 5.15) 10.83% ( 3.51) 0.67% (0.29) 15.26% (2.10) 12.39%** ( 6.55) 4.69% ( 1.16) 3.05% ( 0.67) 5.23% ( 1.04) 16.65% ( 3.21) 6.54% ( 1.46) 9.31% ( 2.47) 16.00%*** ( 7.64) 15.41%** ( 4.85) 8.60%* ( 3.83) 6.22% ( 3.68) 15.62%** ( 4.88) 13.82%*** ( 11.66) 7.77% ( 3.21) 12.18%* ( 3.55)

19 40 37 12 44 52 22 23 23 31 23 30 97 31 76 42 14 2 78 23 14 20 28 45 89 59 75 31 33 23 100 45 25


The 1-day ARs are presented graphically in Fig. 3 for the 10 capital markets with the largest market capitalizations. These markets are arranged from the largest to the smallest and show that the decline in the U.S. capital market, though significantly different from zero, was not as great as eight of the other nine largest world markets (the exception being Toronto). There also appears to be an inverse correlation between a market’s size and its depth of decline; on the event date, the largest markets appear to drop the least. Over the longer 11-day event window, negative returns persisted in all but two global markets (Portugal and Helsinki). Fig. 4 shows the 11-day CARs for the largest capitalized


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Fig. 3. Global capital markets’ event-day abnormal returns following the September 11th terrorist attacks.

markets and again shows that the U.S. market had one of the smallest declines. While most large global capital markets experienced negative 11-day CARs between 5% and 11%, the CAR in the U.S. market was 3.98%. Only the Tokyo market fared better with an 11-day CAR of 3.05%. The last column in Table 2 also shows that, for the most part, global capital markets rebounded fairly quickly after the September 11th attacks. Of the 33 markets, 9 had significant negative CARs over the 11-day event window, but none of these markets is

Fig. 4. Global capital markets’ 11-day cumulative average abnormal returns following the September 11th terrorist attacks.

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generally considered a major global capital market. Moreover, within 20 trading days, 6 of the 33 markets (18%) had returned to their pre-attack levels. Within 40 trading days, 21 markets (64%) had returned to their pre-attack levels, and after 60 trading days, 27 markets (82%) had fully rebounded. It is also interesting to note that the S&P 500 stock index had a negative 11-day CAR of only 3.83%—the fourth best return among the 33 global capital markets. It took just 19 trading days (about one month) for the S&P 500 index to return to its pre-September 11th level. Thus, even though the September 11th attacks were targeted directly at the United States, its capital markets displayed amazing resilience by being affected less severely than capital markets located in most of the other areas of the world and by bouncing back quickly following its initial fall. It should be noted, however, that it could be the case that U.S. capital markets recovered better than many global markets because U.S. capital markets were closed for four trading days following the September 11th attacks. While it is unobservable, it is possible that the elapsed time had a calming effect, as investors were able to take additional time to absorb the news of the attacks and not panic. It is also possible that U.S. investors boosted stocks higher than they would have been otherwise because of an increased emotional patriotic response. 5.2. Iraq’s invasion of Kuwait Table 3 shows the abnormal returns and number of trading days required for each exchange to return to its pre-event level for 18 global capital markets following Iraq’s invasion into Kuwait. Of the 18 markets, 17 had negative event-day ARs, with 9 significant at the 0.01 level, 4 significant at the 0.05 level, and 1 significant at the 0.10 level. The same 17 markets also had negative 11-day CARs, but only 9 markets had CARs that were statistically different from zero (6 at the 0.01 level, 1 at the 0.05 level, and 2 at the 0.10 level). It is interesting to note that the capital markets with the largest negative 11-day CARs are those located in Europe and Asia. For the most part, U.S. capital markets did not fall as sharply and recovered faster than other global capital markets. This is displayed in Fig. 5, and shows the 11-day CARs for the largest global capital markets where data were available. Perhaps this divergence is due to Europe’s greater dependence on foreign oil or its closer proximity to the region, or it may be due to swifter policy responses in America. The results thus far lead to a couple of important questions. Why was there such apparent resiliency in U.S. capital markets? Why did the U.S. capital markets seem to quickly rebound and stabilize? For answers, we now turn to an investigation of a major sector that has great potential in promoting economic stability by providing liquidity: the banking and financial sector.

6. The importance of the banking/financial sector The above analysis suggests that today’s global capital markets are tightly interlinked. We found evidence that U.S. capital markets seem to rebound and stabilize quicker than


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Table 3 Average abnormal returns on global capital markets, following Iraq’s invasion into Kuwait Global stock market

Event-day AR

6-day CAR

11-day CAR

Days to rebounda

S&P 500 Dow Industrials NYSE Nasdaq Toronto London Frankfurt Switzerland Austria Amsterdam Sweden Tokyo Hong Kong South Korea India Singapore Pakistan Johannesburg

1.22%** ( 1.59) 1.35%** ( 1.82) 1.12%** ( 1.64) 1.61%*** ( 3.22) 0.70%* ( 1.16) 1.49%*** ( 2.69) 1.63%*** ( 2.28) 1.86%*** ( 3.69) 2.73%*** ( 2.07) 1.89%*** ( 4.13) 1.26%*** ( 3.33) 1.46%** ( 1.89) 1.98%*** ( 3.04) 1.08% ( 0.72) 2.08%* (2.30) 1.95%*** ( 2.79) 0.31% ( 0.21) 0.35% ( 0.37)

4.90% ( 2.49) 5.79%* ( 3.04) 4.71% ( 2.67) 5.27%** ( 4.08) 3.06% ( 1.98) 4.62%* ( 3.25) 9.53%*** ( 5.19) 9.74%*** ( 7.50) 17.79%*** ( 5.25) 9.00%*** ( 7.64) 6.89%*** ( 7.08) 8.51%** ( 4.28) 13.81%*** ( 8.24) 3.67% ( 0.95) 1.75% (0.75) 13.77%*** ( 7.68) 3.53% ( 0.95) 3.52% ( 1.44)

7.52% ( 2.82) 9.35%* ( 3.63) 7.00% ( 2.93) 7.88%* ( 4.51) 2.99% ( 1.43) 5.96% ( 3.09) 12.76%** ( 5.13) 11.17%*** ( 6.36) 28.93%*** ( 6.31) 11.10%*** ( 6.96) 9.82%*** ( 7.46) 8.75% ( 3.25) 12.98%*** ( 5.73) 5.56% ( 1.06) 4.24% (1.34) 16.85%*** ( 6.94) 6.11% ( 1.21) 2.68% ( 0.81)

131 136 131 131 151 148 796 363 1,912 178 762 >3,183b 135 61 1 677 33 8

Standard errors are in parentheses. a Number of trading days for the market index to return to pre-event level. b Data are as of 30 June 2003. * Statistically significant at the 0.10 level. ** Statistically significant at the 0.05 level. *** Statistically significant at the 0.01 level.

other markets in the world when surprise terrorist/military attacks shock global capital markets than when they did so in earlier times. There seems to be an added degree of resilience today that was lacking yesterday. So, the question is: what has changed and what is different in the United States? We postulate that the efficient functioning of an economy’s banking/financial sector is a key determinant of whether an economy (and hence its capital markets) is able to withstand and quickly absorb exogenous and endogenous shocks. For clues, we investigate the banking and financial sector’s abnormal returns in major global capital markets following the September 11th terrorist attacks. If this sector’s abnormal returns in the United States quickly become less significant over the longer event windows, and if the abnormal returns are less severe than in other countries, then it could be the case that the banking and financial sector is playing a large role in stabilizing the overall market as well as the economy. Table 4 shows the abnormal returns following the September 11th terrorist attacks for banking/financial sector indices from 14 global capital markets where data were available. The table shows that global banking/financial sectors were negatively impacted, but that the U.S. banking/financial sector was impacted less than most other markets. The abnormal returns in the global capital markets are also generally more negative than the overall market abnormal returns reported in Table 2. For the five largest markets where data were

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Fig. 5. Global capital markets’ 11-day cumulative average abnormal returns following Iraq’s invasion of Kuwait.

available, Fig. 6 shows the banking/financial sector declines and the overall market declines over the 11-day event window following the September 11th attacks. In all of the large global capital markets except the NYSE in the U.S., the banking/financial sector abnormal returns are worse than the overall market abnormal returns. Table 4 Average abnormal returns on global capital markets’ banking/financial sectors, following the September 11th terrorist attacks Global stock markets’ Banking/ Financial sectors

Event-day AR

NYSE London Frankfurt Europe-Bloomberg Helsinki Norway Tokyo Hong Kong South Korea Jakarta Kuala Lampur Australia New Zealand Johannesburg

4.79%*** 10.09%*** 10.06%*** 8.54%*** 6.17%*** 5.79%*** 6.50%*** 7.87%*** 13.33%*** 2.83%*** 5.20%*** 3.98%*** 3.67%*** 5.27%***

( 9.23) ( 10.28) ( 8.72) ( 9.66) ( 5.06) ( 4.52) ( 3.03) ( 7.92) ( 5.71) ( 2.81) ( 4.53) ( 6.79) ( 4.75) ( 5.15)

6-day CAR

11-day CAR

Days to rebounda

6.69%** ( 5.01) 8.64%** ( 3.42) 14.54%** ( 4.90) 11.50%*** ( 5.06) 6.43% ( 2.05) 14.18%** ( 4.31) 1.70% ( 0.31) 11.02%** ( 4.31) 13.78% ( 2.29) 3.73% ( 1.44) 13.36%** ( 4.52) 9.46%*** ( 6.27) 11.39%*** ( 5.73) 14.43%*** ( 5.47)

0.45% ( 0.25) 14.14%** ( 4.14) 15.79% ( 3.93) 14.82%** ( 4.82) 11.35% ( 2.67) 25.55%** ( 5.73) 12.18% ( 1.63) 14.34%* ( 4.14) 19.84% ( 2.44) 6.23% ( 1.78) 18.68%** ( 4.67) 11.07%** ( 5.42) 14.93%** ( 5.55) 11.00% ( 3.08)

13 22 42 40 31 107 6 30 28 86 65 26 33 162



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Fig. 6. Global capital markets’ and banking/financial sector 11-day cumulative average abnormal returns following the September 11th terrorist attacks.

One possible reason these returns are better in the U.S. than in other global capital markets is that immediately following the September 11th attacks, the United States’ Federal Reserve System (Fed) took steps to provide liquidity through the banking and financial sector. Perhaps more than anything else, the Fed’s accommodative policy calmed and stabilized the economy through the U.S. banking/financial sector. The best 11-day CAR following the September 11th terrorist attacks for major banking/financial sectors among 14 global capital markets was in the U.S. at 0.45%. With the exception of the capital market returns in Jakarta, all of the other 11-day CARs were double-digit negative returns, and seven markets had statistically significant negative CARs. We also see evidence of a ‘‘flight to safety’’ as rates on U.S. Treasury instruments fell immediately following the attacks. Fig. 7 shows that 10-year Treasury Note yields immediately fell by about 25 basis points when the bond markets reopened on September 13, 2001. U.S. government securities with shorter maturities fell by even greater margins, signifying investor demand to hold ‘‘risk-less’’ assets during this time.

7. Conclusions and policy implications In conclusion, global capital markets today are tightly inter-linked; news spreads rapidly (especially bad news), with quick spillover, or contagion, effects. We find evidence that suggests that modern U.S. capital markets are more resilient than they were in the past and that they recover sooner from terrorist/military attacks than other global capital markets. We also find evidence that suggests the possibility that this increased market resilience can be at least partially explained by a banking/financial sector that provides adequate liquidity to promote market stability and squelch panic.


Fig. 7. Ten-year U.S. treasury note rates 1982-2002.

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The policy implications of this research should not be overlooked. First, because global capital markets are closely and tightly inter-related, policymakers and regulators around the world must always be aware of what is going in other parts of the world. Today’s real-time information economy means that news spreads rapidly and has the potential to have serious negative consequences in a very short time. Thus, it is important for regulators and policymakers to cooperate and communicate more with each other on a regular basis. This includes sharing important information—like unusual stock trading or large dollar transactions—that might have consequences elsewhere, and developing disaster recovery plans that can be quickly put into place in case of a cataclysmic event. Second, the importance of a healthy and stable banking and financial sector and the efficient execution of monetary policies seems paramount to growing economies. The foundations and regulations that underlie U.S. banking and financial markets appear to function efficiently and effectively with the ability to absorb tremendous shocks. For the most part, the payments system in the U.S. kept functioning normally with few reported problems. We suggest that capital markets and banking/financial sectors in growing economies model themselves after those in the United States. This includes, of course, a quick, effective, flexible and responsive monetary authority. Finally, while many terrorist attacks cannot be avoided, others can be, or their disruption minimized, by sharing important information. This includes sharing information with other policymakers and regulators within a nation’s borders as well as across borders. Terrorist and military attacks generally increase the cost of doing business because of added security and increased risks. Today’s global economy requires the efficient and effective use of realtime information.

Acknowledgements The authors thank the participants at DIW Berlin’s June 2002 workshop on ‘‘The Economic Consequences of Global Terrorism,’’ the participants at the German Federal Foreign Office’s program on ‘‘Terrorism and Economic Vulnerability in an Interdependent World,’’ and the seminar participants at National Taiwan University. The authors would especially like to thank Tilman Bru¨ck, Bengt-Arne Wickstro¨m, Valpy FitzGerald, Arye Hillman, Todd Sandler, Mark Chen, David Mauer, Rex Thompson, Ken Robinson, and three anonymous referees for valuable comments on earlier versions of the paper. The views expressed in this paper are not necessarily those of the Federal Reserve Bank of Dallas or the Federal Reserve System. The usual disclaimer regarding errors and omissions applies.

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