International Journal of Advance Study and Research Work (2581-5997)/ Volume 3/Issue 5/May 2020

Effect of Terrorism on Stock Returns

Nasir Khan
Institute of business and management science, The University of Agriculture Peshawar, Pakistan
Email Id: nasirkhan14202@gmail.com

DOI: 10.5281/zenodo.3830410

Abstract

This study aims to investigate the impact of two recent attacks, namely Pulwama and Balakot Airstrike on KSE-100 index. The
study used an event study methodology and Market model to analyze the data. A sample of the top 100 companies is used in this
study. The study used data from the year 2018 to 2019. Two variables are used in this study that is terrorism and stock return.
Terrorism is used as an independent variable and stock returns are used as a dependent variable. The findings of this paper
suggest that the selected events do not affect the stock returns of the KSE-100 index. To encourage and motivate investors both
domestically and internationally the governance system in the country should be fair and transparent to increase the morale of
investors.

Keywords: Terrorism, Stock return, KSE-100 index, event study, market model.

Introduction
The word terrorism was initially heard during the French revolution in the late1700. Terrorism can be defined as “the premeditated
use, or threat of use, of extra-normal violence to obtain a political, religious, or ideological objective through intimidation or fear
directed at the large audience” (Enders & Sandler, 2002). Terrorism is one of the biggest problems faced by countries across the
world. It impacts nations by devastating their economic growth, capital allocation, infrastructure, declining foreign investment,
exports (Kousar et al., 2019). Many kinds of researches can be done to see the impact of terrorism on different industries and
financial markets. The attack on the world trade center by Al-Qaeda can be termed as the single most important factor that changed
the whole world. There are many acts of terrorism, such as the bombing of Indonesia and Madrid, the attack on the world trade
center in the US. Due to all these activities, the economy of many countries got affected.

1.1 Background
Many studies have been conducted around the world on the consequence of terrorism. For example, (Drakos, 2004) studied the
effect of terrorist attacks on tourist visits in three Mediterranean Countries on airline stock listed on various international stock
markets, the results revealed that a significant negative impact on share prices.
Rehman et al., (2018) studied the impact of eleven terrorist attacks on stock prices of the ten major sectors of the KSE-100 index. An
event study is used to analyze the three baleful attacks by using secondary data. The results revealed that out of eleven attacks, three
prominent terrorist incidents have a significant negative impact on stock returns. Gul et al., (2010) examined the impact of terrorist
incidents of three financial markets that is Karachi Stock Exchange, FOREX, and the InterBank market and found that there is an
insignificant but negative impact on these three markets.

1.2 History of Terrorism in Pakistan

The present situation in terms of terrorism in Pakistan is certainly not favorable. According to the South Asia Terrorism Portal
(SATP), there were a total of 446 major incidents in 2014, 310 incidents in 2015, 149 incidents in 2016, 143 in 2017, 67 in 2 018,
And nine in 2019 till the march (South Asia Terrorism Portal).

1.3 Objective of Research

The primary objective of this research is to see the effect of recent terror incidents that is Pulwama attack and Balakot airstrike on
stock returns and find out which company’s returns have suffered the most.

1.4 Research Questions

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 International Journal of Advance Study and Research Work (2581-5997)/ Volume 3/Issue 5/May 2020

RQ1: Does terrorism affects the stock returns of the KSE-100 index? If so, is the effect is significant or insignificant?

Literature Review
Different studies have been conducted on terrorism attacks on stock returns. Charles and Darne (2006) examined the impact of
terrorist attacks on the U.S on September 11, 2001, on international stock markets. They examined 10 daily stock market index using
an Outlier detection methodology. The results revealed that international stock markets experienced large shocks in response to the
terrorist attacks.
Markoulis and Katsikides (2018) studied the effect of terrorist attacks on stock market performance, by employing the event study
methodology to examine the eleven major attacks in the 21st century that occurred in different countries. They considered major
events from 2001 to 2017. The results indicated that earlier events have higher abnormal returns. Some events appear to exhibit a
“spillover” effect influencing international stock markets too.
Kumar and Liu investigated the effect of terrorist attacks on global capital markets and found that the economic consequences of
terrorist attacks tend to spill over. Arif I. (2017) studied the effect of terrorism on Karachi stock market returns. Daily data of the
KSE-100 index were used by the researcher. The results revealed that no relationship between terrorism and the increase in the
systematic risk of KSE-100 index returns.
Apergis and Apergis, (2016) studied the effect of the Paris terrorist attacks on the stock returns and volatility for 22 Global Defense
corporations listed on various stock markets. They employed General Autoregressive Conditional Heteroscedasticity Methodology.
The first part of the empirical analysis explores the ARMA modeling process of al 22 stock returns. Next, ARCH tests used to
identify the presence of ARCH effects. In that sense, they make the GARCH methodological approach. The findings indicated that
the terrorist event has a positive impact on both the returns and volatility of these stocks.
Hassan et al., (2014) studied the impact of terrorism on the Karachi Stock Market. The major attacks are the Assassination of ex-
Prime Minister Benazir Bhutto, attack on Marriott Hotel Islamabad, and attack in Dara Adam Khel was studied on the KSE-100
index. They used an event study methodology to analyze the data. The results indicated that the attack on Marriott Hotel produced a
negative impact throughout the estimation window, Ex-Prime Minister Benazir Bhutto’s assassination resulted in a sharp decline
followed by the immediate recovery, and there was a little negative effect of Dara Adam Khel attack.
Brounrn and Derwall., (2010) examined the effects of terrorist attacks on international stock markets. They used an event study
methodology. The results showed that financial markets react strongly to terror events, but then return recovered swiftly and soon
return to the business to usual.
Pandhi N. (2019) attempts to examine the effect of twenty terrorist attacks on the Indian Stock Market. The study used an event
study methodology to analyze the impact of terror attacks on the S&P BSE 500 companies. The results revealed that, except for a
few attacks, there is no significant impact of the terror attacks on S&P BSE 500 companies.
Muneeswaran and Babu, (2017) checked the impact of terrorist attacks on the stock market of India. The five major terrorist attacks
over the period 2005 to 2009 were taken into consideration. The findings suggest that investors need to wait and should not take
immediate decision on investment, during abnormal events in the market.
Suleman, T.M. (2012) studied the impact of a terrorist attack on returns and volatility of the Karachi Stock Market. They employed
the EGARCH model to analyze the data. The results indicated that terrorist attack news harms the returns of all sector indices.
However, news of these events increased the volatility of the KSE-100 index and a financial sector index.
Hobbs et al., (2016) studied the effect of twenty-eight terrorist and military events on stock returns in between 1963 and 2012. The
findings suggest that the events have a high impact on the market and followed by lower returns. Moreover, the stocks perform
significantly worse in the days of terrorist incidents than in the days of military events.
Essaddam and Karagianis., (2013) examined the effect of terrorism on the stock return volatility of American firms targeted by
terrorist incidents. They used an event study approach and a new bootstrapping technique to analyze the data. The findings showed
that American firms targeted by terrorist attacks experience abnormal volatility on the day of the attack, and the impact of terrorist
attacks on the volatility differs according to the characteristics of the country in which the event occurred. They also present
evidence that terrorism risk is an important factor in explaining the volatility of stock returns.
Kollias et al., (2011) conducted the study to examine the influence of two terrorist incidents- the bomb attack of 11th march 2004 in
Madrid and 7th July 2005 in London. They used event study methodology and GARCH family models for the analysis of the data.
The results showed significant negative abnormal returns are widespread across the majority of sectors in the Spanish markets, but
the effect has been seen in the case of London. The overall findings point out a transitory effect on returns and volatility that does
not last for a longer period.

Research Methodology

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 International Journal of Advance Study and Research Work (2581-5997)/ Volume 3/Issue 5/May 2020

Two different variables are involved in this, terrorism as an independent variable and stock return as the dependent variable. This
study used stock returns as a dependent variable since it attempts to check whether stock returns are affected by terrorist incidents or
not. Two terrorist incidents that are Pulwama attack and Balakot airstrike are taken into consideration.
3.1 Model
We have used the Market Model for the analysis of the data. The market model was also used by (Rehman et al., 2018). The
following formulas were used to calculate stock returns, expected returns, market returns, abnormal returns, and cumulative
abnormal returns.
R it = (P it – P it-1) / P it-1…………………………...............………… Equation 01
Where, R it is the actual return on the share I on day T, Pit is the closing price of the share at the end of day t, and Pit-1 is the closing
price of the share at the end of day t-1. So the popular market model is used in estimating market returns, they are calculated using
the given formula below:
Rmt = (ASPI t – ASPI t-1) / ASPI t-1……………………Equation 02
Where Rmt is the market return on day t, ASPIt is the ASPI for day t, and ASPIt-1 is ASPI for the day before day t. Once we
calculate the market return, the next need to be required to calculate the expected return to measure the abnormal return. Therefore,
it requires to calculate expected return also for test period using the following formula.
E (Rit) = αi - βiRmt……………….......................................………Equation 03
Where E (Rit) is expected return on the share I at the day t in the test period, αi is Estimated regression intercept of share I, βi is
Estimated systematic risk of share I and Rmt are Return on the market portfolio. Here ά and β parameters are ascertained using the
data for the estimation period through MS EXCEL. The abnormal return of individual firms was estimated according to the
following formula.
ARit = Rit – E (Rit) + eit………………....................………………Equation 04
Where, ARit is Abnormal Return on the share I in the test period, E (Rit) is Expected Return on the firm I on day t in the test period
and eit Standard error term. The Abnormal Returns (AR) are the estimated impact of the event on the share price. It is computed as
the estimated Expected Return (ER) subtracted from the actual return. After the calculation of the Expected return and actual return,
abnormal return needs to be derived for the test period of 31 days. In this study, a well-known market model was used to calculate
the Abnormal Returns of shares around the test period (31 days test period). Following formulae were used for this purpose
AARit =1/nΣ 𝐀𝐑 𝒏𝒊=𝟏 it. ……………….......................………………………Equation 05
Where AAR is an average abnormal return for day t, n is the Number of events in the sample, and ARit is abnormal returns of the
firms during the event period. Finally, to measure the impact of terrorist incidents on stock returns needs to be derived cumulative
average abnormal return. CAARs were calculated using the following formulae.
CAARit = ΣAAR t ……………… ..............................................………Equation 06
Where CAARit is Cumulative abnormal average returns up today t, t is Time number of days over which abnormal returns are
calculated and AARt is AAR on the day. Finally the t- value was calculated to examine the statistical significance of the AAR and
the following formulae are used.
t-Value ………………………...............…… Equation 07

3.2 Data
The daily stock prices of companies about the KSE-100 index are obtained from the business recorder
(www.businessrecorder.com) which is the most trusted and authentic source.
3.3 Event Window
The selection of an event window might be an empirical issue, a window that is too long will absorb the impact of other
political, economic, non-economic events that are not of interest in this study and a window that is too short will not be able
to analyze the impact of an event. The researcher used event windows for 20 days before and after an event for analysis and
120 days before the projected time window is taken as the benchmark.

Research Hypothesis
H1: There is a significant relationship between recent selected terrorist attacks and stock returns of the KSE-100 index.
H0: There is no significant relationship between recent selected terrorist attacks and stock
Returns of the KSE-100 index.

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 International Journal of Advance Study and Research Work (2581-5997)/ Volume 3/Issue 5/May 2020

Analysis and Interpretation

Table 1: Effect of Pulwama attack on stock return

EVENT DATE AR CAR T-AR T-CAR

-10 0.000568193 0.000474055 0.039046409 0.034722611
-9 0.005888546 0.006362601 0.250533895 0.301785818
-8 0.001130788 0.007493389 0.034534671 0.333563504
-7 0.001215282 0.008708671 0.072047307 0.395755929
-6 0.000877892 0.009586564 0.068893527 0.459592932
-5 0.000671246 0.01025781 -0.009297796 0.450235928
-4 0.002118579 0.012376389 0.106635573 0.554675196
-3 0.002116413 0.014492802 0.120987759 0.679743527
-2 -0.001816648 0.012676154 -0.085635447 0.597617638
-1 -0.000150366 0.012525788 -0.027495827 0.568242732
0 -0.001600979 0.010924809 -0.080049975 0.492136048
1 0.001187719 0.012112528 0.07181429 0.570301607
2 -0.002402314 0.009710214 -0.100317056 0.469569042
3 -0.006001848 0.003708366 -0.233378394 0.233221236
4 2.85495E-05 0.003736915 0.007162967 0.251337085
5 0.001726105 0.005463021 0.057039298 0.307361359
6 0.002463441 0.007926461 0.083275977 0.385670848
7 -0.004994765 0.002931696 -0.242332588 0.147400662
8 -0.003750226 -0.00081853 -0.149239732 0.010603953
9 0.004468857 0.003650328 0.199434737 0.215069
10 2.5347E-05 0.003675675 -0.005466223 0.207095521

The researcher used the Market model in this study that was also used by many researchers (Rehman et al., 2018). Table 1 represents
the effect of Pulwama attacks on the KSE-100 index. The value of T-CAR less than 2 and did show any significant effect on stock
return.
Table 2: Effect of Balakot Airstrike on Stock

EVENT DATE AR CAR T-AR T-CAR

-10 0.002287431 0.002287431 0.132840542 0.056462285
-9 -0.001800635 0.000648899 -0.076897194 0.142669092
-8 -0.00047028 5.92857E-05 -0.042177653 0.025868357
-7 -0.001554561 -0.001587288 -0.073908259 -0.054983024
-6 0.001336762 -0.000499267 0.079054832 0.015869873
-5 -0.002664853 -0.003094215 -0.12061954 -0.196431324
-4 -0.00609682 -0.009163494 -0.230424479 -0.267389365
-3 0.000271529 -0.008949196 0.008743947 -0.361016923
-2 0.001600508 -0.007325696 0.061454273 -0.774666759
-1 0.002613888 -0.004740291 0.101284504 0.200625096
0 -0.004545656 -0.009196499 -0.217964597 -0.552391808
1 -0.003936414 -0.012940984 -0.150032408 -0.566063272
2 0.004389294 -0.008654013 0.196511701 -1.441852692
3 3.29179E-05 -0.008912253 -0.019791764 -0.25091849
4 0.003659504 -0.005095152 0.186417322 -0.118808038
5 0.002437598 -0.002365087 0.152635659 -0.011161581
6 0.001896236 -0.000933719 0.091040819 0.015234705
7 0.000328515 -0.000539719 -0.015544372 -0.005548656
8 0.001794602 0.001318546 0.087286637 0.060245302
9 -6.57844E-05 0.001248426 -0.005141323 0.188313956
10 0.000207185 0.001441366 0.003763676 0.119952817

Table 2 shows the effect of a Balakot airstrike on the stock return of the KSE-100 index. The table indicates that the value of T-CAR
is less than 2 and it shows the there is an insignificant effect of Balakot airstrike on stock return. The Karachi stock market didn’t
respond to this event.

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 International Journal of Advance Study and Research Work (2581-5997)/ Volume 3/Issue 5/May 2020

Limitations
Firstly the sample size of our research is too small. I only use almost 100 companies. Secondly, I only use one and a half year data
(2018 to 2019). Future research can more year data for best results. We only use terrorism. Other factors other than terrorism may
have affected the performance of the stock market during the period of the study. Such factors include inflation, climate condition,
elections, and technological advancement.

Conclusion
The main objective of this paper is to inspect the impact of two recent terrorist attacks on the KSE-100 index. For this research, we
used the top 100 blue-chip firms in Pakistan Stock Market. The data were obtained from the business recorder and yahoo finance
from the period from July 2018 to August 2019. Based on these findings, we can conclude that both the terrorist incidents have an
insignificant impact on the stock returns of the KSE-100 index. Hence we reject the alternative hypotheses and accept the null
hypothesis H0, that Pulwama attack 14 February 2019; Balakot Airstrike 26 February 2019 had an insignificant impact on stock
returns of the KSE-100 index. Further, this study used only one variable that is bombing. To make this effort successful, daily data
of the top 100 companies have been gathered covering the period from 2018 to 2019. The market model has been applied to analyze
the impact of terrorism on stock market returns of the listed companies with the KSE-100 index. I found that stock returns react
negatively to terrorist incidents. The results of this research support prior studies.

Future Directions
The main focus of this paper is to investigate the effect of these two events. The future researcher should take more attacks and also
they should include more data. Future research will be based on taking international events and find their impact on KSE-100 index.

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