Introduction
Terrorism has been a problem for ages (Law, 2015). Even in the times of Rome, there were groups that attacked the regime because they had a different opinion on a for them (the terrorists) important subject (Law, 2015). In the last two decades there were several terrorist attacks, like the train bombings in Madrid, the suicide bombing in Manchester (during the concert of Ariana Grande) and maybe the biggest of all: the 9/11 attack on the Twin Towers in New York, after this attack the markets were closed for four trading sessions. (Twin, 2006) Apart from this, people also fled the area, because they felt vulnerable and they were scared. (Poe, 2001)
‘Europe is facing an escalating threat from jihadi terrorism. There have never been higher numbers of attack plots per year than in 2014-16. An increasing proportion of plots goes undetected and result in deadly attacks. More people have been killed by jihadi violence in western Europe in 2014-2016 (273 people) than in all previous years combined (267 people). (Nesser, Stenersen, & Oftedal, 2016)
The citation of Nesser, Stenersen and Oftedal describes that jihadi terrorist attacks are playing a more and more important role in our daily lives in Europe. The attacks are happening more frequent nowadays and these frequent attacks kill more people. The European jihadi attacks are mostly linked to two terrorist organizations, these organizations are called ISIS and AL Qaida. (Nesser, Stenersen, & Oftedal, 2016)
Within this thesis, terrorism is an important factor. To be more specific, the Jihadi terrorist attacks performed in Europe. The concept of terrorism is explained by Ender and Sandler (2011). They define this concept as ‘The premeditated use or threat to use violence by individuals or subnational groups to obtain a political or social objective through the intimidation of a large audience beyond that of the immediate victims.’ (p4). This shows that terrorist activity does not consist only out of throwing bombs, but that it is a much more difficult subject. (Crenshaw, 1981)
‘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.’ (Chen & Siems, 2004)
The efficient market hypothesis as described by both Fama, Fisher, Jensen, & Roll (1969) and by Malkiel (1989), argues that in an efficient market every security price is influenced by all available information in a fast and unbiased way. This hypothesis partly comes back in the citation of Chen and Siems (2004).
Much money can be lost, because of market volatility and uncertainty and this gives bad outlooks for all market participants. (Nikkinen & Vähämaa, 2010) For example, New York listed airlines had a stock loss of approximately 53% after the 9/11 attack on the World Trade Center in New York (Drakos, 2004).
Apart from this, stock markets provide an alternative financing investment, which means that the power that banks have becomes less, due to the fact that people have choices. (De Haan, Oosterloo, & Schoenmaker, 2015)
It was argued that Europe faced more attacks than ever before in the period between 2014 and 2016. (Nesser, Stenersen, & Oftedal, 2016) Due to the fact that there is an increasing number of terror events, the interest of many academic researchers has been dedicated to the subject of terror and its effect on the economy (Arin, Ciferri, & Spagnolo, 2008) Until recently, terrorism did not receive much attention from researchers in the field of economics, however, the impact of 9/11, the attacks in Madrid 2004 and the terror in London 2005, showed that these attacks are a new sort of risk that the financing world may be facing. (Chesney, Reshetar, & Karaman, 2011) Because of this new risk for the financing world, research on this topic is economically and academically relevant. This also shows that this is a very contemporary subject.
Because of the fact that this thesis investigates jihadi terrorist attacks executed in Europe, and none of the attacks are performed the Netherlands (in which the AEX is vested), a spillover effect will be measured. A spillover effect refers to the fact that the results of one market can be influenced by results in other markets. (Zhang, Fan, Tsai, & Wei, 2008) Chen and Siems (2004) argue that in this era, news spreads very fast over the whole world. This causes quick spillover effects and this makes global markets more tightly linked. De Haan, Oosterloo and Schoenmaker (2015) also state that European markets are highly integrated.
The effect of terrorist attacks on stock markets has been investigated, a lot of research has been done on this subject. The existing literature is mostly about the effects of the 9/11 attack in New York. However, these investigations are mainly done on stock markets in other continents outside of Europe. The effect of terrorist attacks in Europe on European stock markets has received far less attention. Within this thesis, the effect of European terrorist attacks on European stock markets will be tested, but because Europe does not have one big stock market, only one stock market in Europe will be considered. This will be the Amsterdam Exchange Index.
The aim of this thesis will be to gain knowledge about the effect of terrorist attacks in Europe on the Amsterdam Exchange Index. To accomplish this, the two variables mentioned above are translated into the following research question:
How have jihadi terrorist attacks in Europe affected the Amsterdam Exchange Index?
The rest of this thesis is organized as follows. Part 2 contains a review of the literature where different theories and effects of terrorism on stock markets in different countries are reviewed. Part 3 generates the data and explains why this data is chosen and used. Part 4 develops the method that is used to get the results. Part 5 expands the data together with the methodology into the results. Part 6 includes the discussion of the results and the shortcomings of this research, where after part 7 which is also the last official part of this thesis concludes with a conclusion in which the main findings of the thesis will be explained. Also, in the end, a self-reflection will be added.
Literature Review
theories
Within this thesis, two big theories will be used. The first one is the Efficient Market Hypothesis (paragraph 2.1.1) and the second one is spillover effects (paragraph 2.1.2).
2.1.1 Efficient market hypothesis
The Efficient market hypothesis explained by Fama, Fisher, Jensen, & Roll (1969), holds that all relevant information is affecting the stock prices. This means that the terrorist attacks if they are relevant, should affect the stock prices. They also state that negative information affects the prices negatively and positive information affects prices positively.
Malkiel (1989) argues that the Efficient Market Hypotheses holds that a stock market is efficient if it reflects all information that is relevant for the stocks in the market. Thus it is concerned with how prices behave in markets. (Beechey, Gruen, & Vickery, 2000) This means that if a terrorist attack is relevant for the stock market, a difference in stock prices could be the result of an attack.
Furthermore, Malkiel (1989) also argues that the efficient market hypothesis has 3 forms, namely: the weak efficient market hypothesis form of the in which prices fully reflect information of historical sequence from the prices. This holds that investors cannot have a strategy on the basis of past patterns to get abnormal profits. This form is also called the Random Walk Hypothesis.
The second form is the semi-strong efficient market hypothesis form which states that the current stock prices are not only dependant on past price information, but also on information that is publicly available and relevant for the stocks.
The third and last form is the strong efficient market hypothesis form. In this form all the to every participant known information is included in the prices, hence the prices fully reflect all the information. This means that even the people that have the privilege of knowing private information are not able to use this information to get abnormal stock returns.
So in an efficient market, every security price is influenced by different relevant information sources based on the form of the efficient market. And because of this, provides us with un-aligned estimates of underlying values (Basu, 1977). A few decades ago, this Efficient Market Hypothesis was accepted by most researchers. It was believed that when information arose, it would spread quickly and it would be included in stocks in no time. There exists a lot of empirical evidence that supports the Efficient market hypothesis, but questions still exist about its validity.
By some, it is believed that the price-earnings ratio is a better provider of future investment performance of a security than the Efficient Market Hypothesis. The P/E Ratio can be calculated with the following formula:
Price-Earnings Ratio= (Market Value per Share)/(Earnings per Share)
It is claimed that low P/E ratios outperform high P/E ratios, but these low P/E ratios have such high returns that it is inconsistent with the Efficient market hypothesis (Basu, 1977).
However, for this research, the P/E ratio is not relevant because the P/E ratios are not compared with each other. The Efficient Market Hypothesis is relevant because this thesis it is measured if a terrorist attack has any influence on the stock market.
Others claim that the future stock prices have become a little predictable, for their predicting they take a past stock price pattern and certain fundamental valuation metrics. In this way, investors should be able to earn excess rates of return. (Malkiel B. G., 2003)
Still, this does not go for this research, because terrorist attacks are not predictable. Therefore investors cannot take a past stock price pattern and because of this, the Efficient Market Hypothesis is theoretically correct within this research.
Timmerman & Granger (2004) also argue that investors are always’s trying to find predictable patterns, they state that if a pattern is found then others will discover this also and therefore this pattern will unlikely be there for long periods of time. So even if a pattern of terrorist attacks is found, it will only have a short effect.
If the Efficient Market Hypothesis holds within this research, then the shock of the terrorist attacks should generate a negative spillover effect from the place where the attack has been taken place to the Amsterdam Exchange Index. These spillovers will be discussed in the next subsection.
2.1.2 Spillover Effects
Spillover or contagion effects is the phenomenon that information coming from a region affects the daily situation in another region (Enders, Sandler, & Gaibulloev, 2011). Within this thesis, this would be the information that a terrorist attack has happened and what the effect of that will be on a particular stock market, namely the AEX.
The reason that these spillovers happen due to terrorist attacks is fear. That fear of terrorism has an effect on stock markets has already been proven by Shell (2004). Chaudhry, Roubaud, Akhter, & Shahbaz (2018) also state that there is evidence that stock markets in one country are affected by terrorist attacks in other regions. This is, according to them, because of market integration. It is said that in the economy of today, which is a global economy. Every stock market is linked with other stock markets through trade, through financial market integration and through foreign direct investment (Chaudhry, Roubaud, Akhter, & Shahbaz, 2018). Examples of spillovers used by Chaudhry, Roubaud, Akhter, & Shahbaz (2018) are the 9/11 attack of New York but also the global financial crisis. These spillovers happened because of a strong linkage existing between the United States economy and the economy of countries in Europe.
Corbet, Gurdgiev, & Meegan (2017) Find that terroristic attacks in domestic countries do cause volatility in the domestic stock market, but they do not always have spillover effects. Terrorist attacks in Europe, for instance, do not have significant effects on the volatility in Spain or Ireland. Still, they find that bombings and Explosions caused by ISIL (Islamic State of Iraq and Levant, so jihadi attacks) in Europe do significantly affect the volatility of stock markets in all of Europe. However for instance infrastructure attacks do not significantly affect markets all over Europe.
In recent times information spreads faster than ever, bad news even quicker than good news. (Chen & Siems, 2004) This means that global markets are even more tightly linked than they were before.
One of the reasons that the news spreads more quickly is that the flow of international investment has been constantly growing in recent years. Reasons for this are relaxation of control on movements of capital and foreign exchange transactions (Arshanapalli & Doukas, 1993). Apart from this, the innovation of computer and communication technology (for instance the internet, mobile cellphones) makes it easier to find out what happens in other parts of the world.
Because of these new technologies of the information age, new sorts of terrorism arise too. For instance cyber terrorism (Zanini & Edwards, 2001). Although this thesis won’t serve that topic, it is still interesting to name it here.
Back to the topic, the reason that these spillover effects are important here can only be explained by looking into how these attacks in other countries could possibly affect the AEX. The main reason for this is that people are scared. Chen & Siems (2004) argue that when a terrorist attack happens, investors often back out of the market and then search for other options that are safer to invest in. This panic part proves that people are afraid to lose money and because of this risk-averse attitude the return of a market could be negatively affected.
Empirical findings
Different kinds of financial and stock markets exist, for instance, the capital market (where you can trade stocks and bonds) or the derivative market (Pagano, 1993).
Well-functioning stock markets are, in fact, important contributors to long-run economic growth. (Levine & Zervos, 1998) So, if these well-functioning stock markets are affected by negative factors, it could mean trouble for a countries long-term economic growth. This means that if an act of terrorism has a negative effect on the stock market then the stock market has a negative effect on the economy as a whole. Hence it is important that the newly posed threat of terrorism is properly examined.
It is already known from some of the terrorist attacks that there was an effect on a financial market. There have been more studies about the effect of terrorism on the economy and some of the more interesting papers and empirical findings are discussed here.
Israel and Palistine
Eckstein and Tsiddon (2004) did research about how the terror in Israel affected their economy. The main focus of the paper is one dimension of insecurity. They state that when terror increases, people’s lives get shorter and less certain. Because of these threat’s both individuals and governments tend to change behavior and so the total costs of terror emerge from the government as well as the people living in the country. They also state that terrorist attacks have different impacts on different economic activities, the impact on investments is three times larger than for instance the impact on GDP. They conclude that even though the government does spend more on security while facing terror, the lives of people are still less secure.
Eldor and Melnick (2004) dig deeper into the subject of the effects of terror on stock and foreign exchange markets in the middle east with the focus mainly on Israel and Palestine. They have derived some really interesting conclusions, by asking 4 questions.
1 Did the terror affect the stock and currency markets?
The terror did affect both markets. The stock market was affected negatively, a market drop occurred. The exchange rate was affected positively, a devaluation occurred.
2 Are all consequences alike?
Not all consequences are alike, some attacks have a permanent consequence and others have a transitory effect. Apart from this, the stock market was affected negatively and the exchange market was affected negatively.
3 Is the effect permanent?
This depends on the kind of attack. Suicide attacks have mainly permanent effects on the prices of the stock market, while other attacks such as attacks on transport have a more transitory effect on the stock market prices.
4 Does market sensitivity to terror diminish over time?
The market sensitivity to terror does not diminish over time, so a routine of terror attacks cannot be spoken of in this paper.
The conclusion of this paper is that Palestinian terror attacks have had a big permanent impact on the stock market in Israel, however, the attacks did not affect the foreign currency market permanently. Out of the research of we can conclude that terrorist attacks can have a big effect on the stock markets in the Middle East.
Mnasri & Nechi (2016) investigate stock market volatility of 12 MENA countries. An event – study method is used in this paper. The conclusion is that in this region the amount of attacks is high, this might be the reason for fear to exist more in this region than in other parts of the world. This might have an effect on the long-term investments. Furthermore, an impact on the volatility of the market is found. This impact is said to last for approximately 20 trading days. Which is considered a relatively long time for the impact of an attack.
United States
The 9/11 attack on the World Trade Centre in New York had as a consequence that the listed airlines had a stock loss of approximately 53% (Drakos, 2004). This was, according to Drakos (2004) a double blow, because the airline industry was starting to have a stock loss already. Even though this effect was found for one of the listed companies and not on the whole market, the results are still interesting because an effect of terrorism is shown in this paper.
Furthermore, this paper investigates a spillover effect that is found as a result of the 9/11 attack. It is argued that the spillover effect is large because there are major global stock losses.
Carter & Simkins (2004) Did similar research on the 9/11 attack. They also concluded that the September 11th attack had serious consequences for the United States commercial airlines.
Brounen & Derwall (2010) have investigated the price reactions of international financial markets after 31 different terrorist attacks in their paper. It is claimed that wall street closed their trading sessions one hour after the disasters of 9/11. Three days after closing they reopened and there was an index loss of over 7% on the Dow Jones.
They used an event – study method (somewhat equal to the one that is used in this thesis) that focusses on abnormal returns for their research and they compared this to the results after unanticipated catastrophic events. The conclusion of their paper was that the terror attacks have bigger effects on the economy than unanticipated catastrophic events. Apart from this, something else was found, according to their research only the 9/11 attack had a significant impact on the prices that lasted for more than only the day that it occurred on.
Chen & Siems (2004) investigated the spillover effect of global terrorist attacks in the United States. For their research, an event-study method has been used. Their focus lays on the abnormal returns that are produced by firms as a result of a specific event. They base their investigation on the efficient market hypothesis. In their methodology, the event-day abnormal returns are used to show the immediate reaction to the attacks. Apart from this, also the 6-day cumulative average return and the 11-day cumulative average return are used to show the effect of the attacks on longer periods and to show the ability of the market to recover from the attacks.
As already partly said in the spillover chapter above Chen & Siems (2004) conclude that global markets nowadays are tightly linked with each other. News spreads rapidly across the globe which makes spillover effects a simple result of that. Another conclusion is that the capital markets of the United States are more elastic than they were before, making them able to recover faster from terrorist attacks than other markets. Lastly, it is concluded that a spillover effect does exist in the United States markets.
Europe
In the research paper of Johnston and Nedelescu (2005), it is claimed that new patterns are shown by terrorism. The targets shifted from military to civilians, which include individuals and activities of business, in recent years. It is shown that international terrorists most prefer businesses as their target since 1998. In their research cases are examined in which financial markets are affected by terrorist attacks.
Their findings are interesting because they conclude that different attacks have different consequences. The 11th September attack has a more global and both a short and a long-run effect on stock markets. For instance, the New York Stock Exchange never opened on the 11th of September and the United States security market never opened until the 17th of September. The European markets had a decline after the 11th of September, but the decline was even bigger after the 17th of September due to spillover effects that happened after the reopening of the US securities market. Thus the 11th of September attack affected markets worldwide.
In Madrid, the terrorist attack had a more regional and short-run effect. The Dow Jones Euro STOXX is said to have had a decline of approximately 3 percent after the attack and dropped continually a few days after, but it did almost fully recover before the end of the month. The same goes for the standard and poor 500’s. they also recovered to the pre-attack levels in no more than one month. The impacts of different attacks can thus be very different.
There is, however, something that the two attacks do have in common. This is the deterioration of investor confidence beyond the national borders because of contagion effects. This investors’ confidence seems to be more sensible in Europe than in the US (this is also argued by Chen and Siems (2004)), because in both cases the US markets suffer less than the European market and they recover faster, however, both of the markets are recovered within weeks.
In the paper of Arin, Ciferri, & Spagnolo (2008) it is investigated if there exists a statistically significant causality effect coming from the terrorist attacks on stock market returns and volatility in 6 different countries. They have done this by using a time-series framework for a multi-country sample. Apart from this, they have analyzed the terror effects on higher moments of returns.
The countries that were investigated are Indonesia, Israel, Spain, Thailand, Turkey and the UK. For this thesis, Spain and the UK will be the important countries to look into.
They provide evidence that the impact on stock markets is different per country. Looking at the effect of terrorist attacks on stock markets in all of the countries, they measure that the causality effect is significantly negative. For Indonesia, Spain, and Turkey this degree of causality is higher than for the other countries. The conditional variance coefficients do not differ between the countries however the magnitude of the causality effect is highest in Indonesia, Israel, and Turkey. Furthermore, the GARCH-in-mean coefficient is negative for all of the countries which is proof of the effect of volatility of terroristic events on the stock markets.
The conclusion of this paper is that in Spain and in the UK (which was considered to be still European when their paper was written) the impact of the attacks on the stock markets was lower than in other parts of the world. It was argued that the reason for this lower impact is that the investors are more resilient in those countries. This could be explained by looking at the awareness of investors about the western countries being more able to absorb shocks caused by terrorist attacks.
Hypothesis Development
In the first sections of the literature review, the theories that are used have been discussed are the basis of this thesis. The Efficient Market Hypothesis argues that when markets are efficient, then all relevant information that is available has an influence on the stock market (Fama, Fisher, Jensen, & Roll, 1969). This holds that market prices should be affected by the terrorist attacks if the market is efficient and if these attacks are relevant.
The second theory is the spillover effect. It is argued that when something happens in one part of the world, it could have an effect on other parts of the world (Enders, Sandler, & Gaibulloev, 2011). This means that an attack, that happened in Spain, could have an effect on the stock market of Amsterdam. Now a day’s this spillover effect should be higher than ever, because of recent technological developments (Chen & Siems, 2004).
In the second section of the literature review, the findings other papers have been described. Where Eckstein & Tsiddon (2004) conclude that terrorist attacks in Israel have a significant effect on the economy as a whole, Eldor & Melnick (2004) cover a more specific part of the economy namely the foreign exchange market and the stock market in the middle east. They conclude that the effect of the terrorist attacks is negative on the stock market and positive on the foreign exchange market. Apart from this, they also find that the effect of attacks does not diminish over time, this means that if an attack would take place again a couple of years later, the effects would remain the same. Mnasri & Nechi (2016) find that the impact of terrorist attacks on the stock markets in MENA countries is approximately 20 day’s which is considered to be relatively long.
In the United States, Drakos (2004) investigated a specific branch of companies. Namely the airline companies and the effect was big significant and negative. Also, a large spillover effect was found. Brounen & Derwall (2010) us an event-study to argue that terrorist attacks have a bigger effect on the economy than unanticipated catastrophic events. And they found that the only attack that affected the prices for more than a day was the 11th of September attack. Chen & Siems (2004) also use an event – study and abnormal returns in their research. They conclude that spillover effects do exist, also global markets are more tightly linked according to their research and the capital markets of the United States are more elastic than other markets.
In Europe, Johnston & Nedelescu (2006) argue that the attacks in Madrid are more regional and the effect is only for a short period of time. The attacks in New York, however, have a much bigger impact and for a longer period of time also. Arin, Ciferri, & Spagnolo (2008) argue that in Spain and in the United Kingdom the impact of the attacks on stock markets is lower than in Indonesia, Israel, Thailand, and Turkey. But there is also an impact in Spain and the United Kingdom.
Summarizing all of this information, most of the conclusions where that the terrorist attacks did have a negative effect on the economy and the stock markets, but the effect was only there for a short period of time. However, one attack had a longer influence on the stock markets and this was the 9/11 attack in New York.
Because of the spillover effects found in the researches and because of the negative results found in other investigations the following hypothesis is formed.
Jihadi terrorist attacks in Europe have a negative effect on the Amsterdam Exchange Index.