Impact Of Terrorist Attacks On Stock Returns And Investors' Sentiment In The Context Of Pakistan Stock Market

Terrorism not only harms the physical infrastructure and hamper the economic activity in a country but also it diverts the scarce economic resources away from alternative development projects.The stock market,being the barometer of economic activity,is thus likely to be adversely affected by incidents of terrorism.Pakistan is on the front-line of terrorism due to its contiguity with Afghanistan and has been the direct victim of ongoing terrorist attacks since after 9/11 incident.Though the intensity and magnitude of terrorism varied over time,Pakistan has continuously been troubled by terrorism during the past two decades.The case of Pakistan is unlike western countries which are seldom directly affected by terrorist attacks.Pakistan provides an appropriate setting to investigate the stock market ramifications of an ongoing streak of terrorism.It also provides an opportunity to investigate whether or not,an additional act of terror loses relevance to the stock market,once terrorism incidents become a norm?This study thus aims at investigating the impact of terrorism on the stock market in Pakistan.It first attempts to establish a long-run relationship between the 'intensity of terrorism' and the stock market' s reaction.To establish the relationship between terrorism intensity and the market abnormal returns fifteen years(2002-2016)of data is analyzed.For this purpose,the data on individual terrorist incidents is obtained from the Global Terrorism Database.Multiple measures of terrorism intensity and market abnormal returns are computed for this analysis and estimations are made by employing a GARCH model.The OLS estimation with robust standard errors is also employed for robustness.The estimated results provide strong empirical evidence that higher intensity of terrorism is associated with greater negative abnormal returns.Terrorist attacks have been a common phenomenon in Pakistan during our sample period.One may expect that once terrorism becomes a common phenomenon and the people(investors)become accustomed to terrorist incidents,an additional act may not significantly affect the stock market.To test this proposition a comprehensive analysis of four major terrorist incidents,spread across our sample period,was performed.To this end,we employ event study methodology where a window of analysis surrounding each of these incidents is defined and the return behaviour of individual stocks in the market is analyzed.This was followed by a computation of stock-wise Abnormal Return(AR)and Cumulative Abnormal Returns(CAR)for trading days immediately after the terrorist incidents.Also,the market-wise average of AR and CAR was computed to assess the significance based on underlying individual stocks.For a more sophisticated analysis,regression analysis was performed on the abnormal returns of all individual stocks using three dummy variables which respectively indicate the first,second,and third trading day after the incident.The significance of the coefficients on dummy variables is computed based on robust standard errors clustered at the industry level.The estimated results from the event study analysis,in each of four analyzed cases,provide overwhelming empirical evidence that the stock market's reaction to all four terrorist incidents was significantly adverse.It is thus inferred that notwithstanding that the terrorism incidents are 'commonplace' in Pakistan during our sample period,an additional major terrorist incident significantly adversely affects the stocks' returns in the market.This supports our hypothesis and lends further credence to the proverbial expression "the things could always get worse".It leads us to conclude that despite terrorist incidents being commonplace the stock market remains responsive to additional terrorist incidents in the country during our sample period.Next,this study also investigates whether the effects of terrorism on the stock market are limited to some industries or are felt across the board.Though terrorism hampers the overall economic activity in the country the existing literature argues that certain industries(defense,construction,etc.)may benefit from terrorism.However,unlike other western countries,Pakistan does not have an established defence industry and due to the ongoing nature of these conflicts,the reconstruction activity is negligible during our sample period.Thus,we propose and test the hypothesis that terrorism has indiscriminate effects on all industries in Pakistan.In this regard,an industry-wide analysis is performed on the four selected events of the study.The industry-wide estimated results reveal that the adverse effects of terrorist incidents are felt(though with varying magnitude)across all sectors of the economy.Lastly,this study attempts to address the psychological impact of terrorism for investors in Pakistan stock market.Apart from a direct economic loss,major terrorist incidents create/exacerbate uncertainty and fear in the market.The investors are likely to over-respond to such incidents and once the dust settles the market tend to recover.The analysis of cumulative abnormal returns in the aftermaths of terrorist incidents and the volume analysis provide strong evidence that the terrorist incidents adversely affect investors' sentiments and confidence in the market as manifested through relatively feeble trading volumes.This study contributes to the existing literature by exploring the interaction of terrorism with stock market returns,the effect of major terrorist attacks on firm's stock returns,industries stock return and investor sentiment,which are important areas of economic and finance research.It also proposes a new measure of stock returns.The results support the related theories and hypotheses on the studied phenomenon.Furthermore,this study extends the existing empirical context to Pakistan,whereas prior studies focused on the U.S/Europe/Israel.This study brings some important implications and new insights for stock markets and investors.For the government officials,it is important to know the causes of terrorism and make such policies that would lead to less disparity.The government should always back the stock market if it is on the vulnerable situation.Similarly,the Securities and Exchange Commission of Pakistan should require companies to hold extra reserves as a buffer against terrorism risk.The study is based on the effect of terrorism on the stock market returns and investors sentiments.The investment firms should be aware of the repercussions on the stock market and how an investment will react to a terrorist event.