European Markets’ Reactions to Exogenous Shocks: A High Frequency Data Analysis of the 2005 London Bombings

Abstract

Terrorist incidents exert a negative, albeit usually short-lived, impact on markets and equity returns. Given the integration of global financial markets, mega-terrorist events also have a high contagion potential with their shock waves being transmitted across countries and markets. This paper investigates the cross-market transmission of the London Stock Exchange’s reaction to the terrorist attacks of 2005. It focuses on how this reaction was transmitted to two other major European stock exchanges: Frankfurt and Paris. To this effect, high frequency intraday data are used and multivariate Genralised Autorgressive Conditional Heteroskedasticity (GARCH) models are employed. This type of data help reveal a more accurate picture of markets’ reaction to exogenous shocks, such as a terrorist attack, and thus allow more reliable inferences. Findings reported herein indicate that the volatility of stock market returns is increased in all cases examined.

Keywords

• capital markets
• contagion
• terrorism
• multivariate GARCH