The financial costs of terrorism: evidence from Germany.

• Author: Bouoiyour, Jamal

1. Introduction

   In recent years, terror attacks became more enduring and widespread than in previous years. The terrorism is a very complicated geopolitical issue that hugely harms the international peace, the security of cities, governments, nations and markets worldwide. In recent years, terror attacks became more enduring and widespread than in previous years. The terrorism is a very complicated geopolitical issue that hugely harms the international peace, the security of cities, governments, nations and markets worldwide. Although an immense amount of thought and tremendous interest have been devoted to the direct costs caused by terror attacks including severe physical injuries, deaths, damaged goods, harmed infrastructure as well as the emotional and behavioral effects of terrorism have been largely studied (inter alia: Chen and Siems 2004; Karolyi and Martell 2010), much less attention has been given to the indirect costs of terrorism including the financial costs. Indeed, the investigation of the effects of terrorism on financial markets became more frequent at the academic level since the unprecedented 11 September Terrorist attacks (for example, Chen and Siems 2004, Karolyi and Martell 2005, among others). Chen and Siems (2004) carried out an event study methodology to assess the impact of terrorism on US capital markets. The analysis revealed that that the US capital markets returns to the normal state promptly after an attack. Karolyi and Martell (2005) utilized the same method to examine the reactions of equity prices to terror attacks and to determine in which countries companies are targets. They deduced that the losses caused by terrorism are more pronounced when the targets are located in more democratic or richer countries. They added that human capital losses are significantly linked to sharp adverse stock price responses. Likewise, Johnston and Nedelescu (2005) assessed the role of market efficiency to safeguard against unforeseen terrorist attacks and found that the appropriate response of the authorities and coordinated efforts among them can enable financial markets to be more efficient in effectively coping with sudden terror chocks. Arin et al. (2008) explored the impact of terror on different financial markets, and showed that terror exerted a significant and stronger influence on both stock market returns and the stock market volatility, and the magnitude of these effects are likely to be more pronounced in emerging markets.

   However, as far as the impacts of terror on disaggregated stock markets is concerned, a very limited strand of literature has been found (see, for instance, Drakos and Kutan 2003; Schiereck and Zeidler 2009; Kolaric and chiereck 2016; Apergis and Apergis 2017; Hadi et al. 2019). For instance, Drakos and Kutan (2003) explored the terror consequences on tourism industries by delving into the cases of Greece, Israel, and Turkey. Significant contagion effects of terrorism on their respective equity markets were consistently shown. Schiereck and Zeidler (2009) assessed the responses of financial and banking services shares to terrorist attacks and found significant detrimental effects. Kolaric and chiereck (2016) empirically examined the dynamics of airline stock prices over the heightened uncertainty surrounding the Paris and Brussels terror attacks. They documented that the stock prices follow the efficient market hypothesis. By meticulously evaluating the performances of 27 biggest US, Canadian, and European airline companies, they showed that terrorism harmfully affect airline industries. Further, Apergis and Apergis (2017) tried to address whether the Paris terror attack exacerbated the stock market volatility of the biggest defense industries. They documented that terrorism intensified the volatility of defense stocks. More recently, Hada et al. (2019) studied the impact of terrorism on the performances tourism, travel, and leisure companies (in terms of returns and volatility) in China, France, Spain, Thailand, Turkey, the United Kingdom, and the United States. A harmfull effect is found for all the countries under study, with the excption of China.

   To our best knowledge, no study has been tried to empirically assess the impacts of terror shocks on the different sectors of German economy. In 2016, Germany has experienced successive terror attacks with 22 innocent people killed and 111 injured. Not to bring out the human tragedy, the panic and horror caused by terror, the economic implications might be ruinous for an economy where the total contribution of travel and tourism to GDP exceeds 8% in 2015. According to the World Data Atlas (1), the tourist bookings to Berlin were collapsed by approximately 6.6%, dominantly owing to concerns regarding security in Europe (and Germany, in particular). The terror incidents occurring in Germany over 2016 were not isolated events. In 2015 and 2016, the terrorist attacks happened in various countries where tourism represents a prominent share of GDP, including France (9.1%), U.K. (11.2%), Italy (10.2%), US (8.2%), Thailand (20.8%), Egypt (11.5%), Tunisia (12.6%) and Turkey (12.9%), among others. Following the Paris, Brussels and Berlin terror attacks, France, Belgium and Germany are on alert. In Figure A.1 (Appendix), countries are color-coded and numbered based on the extent of terror threat.

   The present research explores two events occurring in Germany's largest and most visited cities (in particular, Berlin and Munich) to evaluate how the risk and return in the German stock market changed as a reaction to those events. The responses of sectoral German stock market to each event is employed to rigorously determine the extent and the direction of change. In particular, the present analysis conducts a modified event study methodology (2) that evaluates the abnormal returns attitudes for various industries of the German share market around the days of Munich attack (July 22, 2016) and Berlin terror shock (December 19, 2016). The event study methodology quantifies the economic impact of an event on the returns of a specific company, also called abnormal returns. The latter are determined by subtracting the returns that have been realized when the studied event would not have happened from the contemporaneous returns of the equities.

   We deduce from our results that, the effect of uncertainty around Munich and Berlin terror attacks is sector-specific. The airline, hotels, leisure and telecommunications sectors were the most harmfully influenced by the attacks. Other sectors proved their great resilience (in particular, banking and financial services and defense). Some elements have been advanced to explain the heterogeneous reactions of the disaggregated German...