Executive Summary:
Widespread speculation, assumptions, and ideas surround the impact of 9/11 on financial markets and its implications for future global order. The research conducted by Dr. Andrew Chen, Distinguished Finance Professor at SMU Cox, and Dr. Thomas Siems, a Senior Economist at the Federal Reserve Bank of Dallas, provides evidence about the effects of 9/11 on global capital markets as well as that of other incidences of terrorism and military invasions. Findings from the study indicate that US capital markets are more resilient than in the past and recover sooner than other global capital markets. This increased market resilience can be partially explained by a stable banking/financial sector that provides liquidity to promote market stability and to minimize panic in investment community. The policy implications for global cooperation are very tangible.
The Study
The authors of the study examined the US capital market responses to14 terrorist/military attacks dating back to 1915 and the global capital market responses to Iraq’s invasion of Kuwait and the September 11, 2001 terrorist attacks. One general conclusion is that terrorist and military attacks have great potential to effect capital markets around the world in a short period of time. News travels fast. But, US markets have become more resilient and are better able to absorb shocks brought on by such events. An economy’s banking/financial sector seems to be an important force in returning markets to relative stability. “Quite often banking institutions need to offer liquidity. Shortly after 9/11, the Chairman of the Fed came out and promised to provide adequate liquidity to the financial system, and that in turn calmed the markets. This response allowed the US to bounce back faster than other countries,” Dr. Chen explained.
The Findings
A number of past terrorist and military attacks have resulted in extreme stock market volatility, rocking US capital markets. In order to determine how different in size and duration the post-event stock returns were from the past averages, two event windows of 6-day and 11-day cumulative abnormal returns (CARs) were analyzed. Of the past 14 terrorist/military attacks examined, three events had significant negative 6-day CARs, with all three of the events having double-digit 11-day negative CARs. These were the sinking of the luxury cruise ship Lusitania by a torpedo in 1915; Hitler’s invasion of France on May 12, 1940; and the attack on South Korea by the North Korean People’s Army on June 25, 1950. During the time windows, news continued to have a negative effect for these three events. Other noteworthy results indicate that it took 795 days (about 2 1/2 years) for trading to return to the pre-attack level for the invasion of France; 232 days for the attack on Pearl Harbor; and 134 days for trading to resume to pre-attack levels when Iraq invaded Kuwait on August 2nd of 1990.
US Capital Markets and 9/11
The terrorist attacks of September 11, 2001 were an event with statistically significant negative cumulative abnormal returns or CARs. Over the 6-day window the CAR was –10.57% and over the 11-day window, the CAR was –7.90%. Based on a chronological arrangement, the event CARs indicate a trend toward greater capital market resilience in the US. The Dow returned to its pre-attack trading level in 40 days (about two months) following “the most horrific attack on US soil since the war of 1812.”
While difficult to explain and draw definitive conclusions, several reasons may explain this increased market resilience. First, the improved technology makes communications and information acquisition and transmission more timely and accurate. This aids markets in being more efficient alongside having more market participants. Additionally, more flexible and appropriate monetary and fiscal policies may have assured markets and promoted stability by providing proper levels of liquidity in a time of crisis.
All 33 global capital markets in the sample experienced significant negative abnormal returns the day investors first learned of the terrorist attacks on the US. Of the ten capital markets with the largest market capitalizations, the decline in the US capital market was not as great as eight of the other nine which include: London, Tokyo, Frankfurt, Paris, Amsterdam, Switzerland, Italy, Hong Kong (the exception being Toronto). Additionally, the largest markets appear to have dropped the least. While most global capital markets experienced negative 11-day CARs between 5% and 11%, the CAR of the US market was –3.98%. Only Tokyo fared better with an 11-day CAR of –3.05%. Moreover, within 20 trading days, 6 of the 33 markets had returned to pre-event levels; after 40 days, 21 markets had returned; and after 60 days, 27 markets recovered for an 82% recovery rate of the 33 markets.
While the attacks were targeted directly at the US, 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 the initial fall. It could be the case, however, since US markets were closed for four trading days following the 9/11 attacks, the elapsed time had a calming effect on investors whereby they could absorb the news and not panic. Investors may have boosted stocks higher than they would have otherwise because of an increased emotional patriotic response.
Iraq’s invasion of Kuwait had similar trends as 9/11 with respect to US capital markets and European and Asian markets. The capital markets with the largest 11-day CARs are located in Europe and Asia. In general, US capital markets did not fall as sharply and recovered faster than other global capital markets. The divergence might be explained by Europe’s greater dependence on foreign oil or closer proximity to the region, or it may be due to swifter policy responses in America.
Importance of the Banking/Financial Sector
The findings and analysis in the research indicate that US capital markets seem to rebound and stabilize quicker than other global markets when surprise terrorist or military attacks shock global capital markets. The analysis also suggests that global capital markets are tightly interlinked. The authors 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. It is possible that the banking and financial sector is playing a large role in stabilizing the overall market as well as the economy. Additionally, the Fed took steps to provide liquidity, and perhaps more than anything else this accommodative policy calmed and stabilized the economy through the banking and financial sector. There was also evidence of a “flight to safety” as rates on US Treasury instruments fell immediately following the September 11 attacks and US investors had increased demand to hold risk-less assets during this time.
Conclusions and Policy Implications
With today’s tightly interlinked global capital markets, news spreads rapidly with quick spillover or contagion effects (especially bad news). US capital markets are more resilient than they were in the past and they recover quicker than other capital markets. This may partially be explained by a banking/financial sector that provides adequate liquidity thus promoting stability and curbing panic.
Policymakers and regulators around the world must always be aware of what is happening in other parts of the world. As Dr. Chen explained, “If something happens in one place, whether it’s the US or Europe, all other countries and their stock markets will be affected. Therefore, we cannot close our doors and not care about what is happening in Asia or Europe; everything is linked, economies, stock markets, and so on.” Because of the linkages, awareness, cooperation and communication by regulators and policymakers need to be regular and ongoing. Sharing information like unusual stock trading or large dollar transactions is very important as it could have consequences elsewhere. The recent stopping of particular flights to the US by British Airways is a very important form of reporting and cooperating.
Having a healthy and stable banking and financial sector and efficient execution of monetary policy appears paramount for growing economies. The US markets function efficiently and effectively with the capacity to absorb tremendous shocks. The authors suggest that a fast-acting, effective, flexible monetary authority, modeled after the US, may prove beneficial to other countries. Terrorist and military attacks generally increase the cost of conducting business due to added security needs and increased risks. Today’s global economy requires using real-time information effectively and increasing global cooperation to prevent or disrupt future attacks. |
