Does terrorism affect the stock market returns and volatility? Evidence from Pakistan's stock exchange

• Published date: 01 February 2022
• Author: Dilawar Khan,Arif Ullah,Wajid Alim,Ihtisham ul Haq
• Date: 01 February 2022
• DOI: http://doi.org/10.1002/pa.2304

ACADEMIC PAPER

Does terrorism affect the stock market returns and volatility?

Evidence from Pakistan's stock exchange

Dilawar Khan

1

| Arif Ullah

2

| Wajid Alim

3

| Ihtisham ul Haq

1

1

Department of Economics, Kohat University

of Science & Technology, Kohat, Khyber

Pakhtunkhwa, Pakistan

2

Department of Economics, Preston

University, Kohat, Khyber Pakhtunkhwa,

Pakistan

3

Institute of Business Studies, Kohat

University of Science & Technology, Kohat,

Khyber Pakhtunkhwa, Pakistan

Correspondence

Arif Ullah, Department of Economics, Preston

University, Kohat 26000, Khyber

Pakhtunkhwa, Pakistan.

Email: arifecon@yahoo.com

During the last few decades, the number of terrorist's attacks has been increased to

a great extent in the world, which possibly enhances the fear of investors and influ-

ences long-term investment commitments. It is important to explore how the finan-

cial market reacts to terror events in order to dictate the suitable policy

recommendations. This study examines whether terrorism exerts a significant effect

on stock market returns and volatility by examining the daily time series data for

Pakistan from the period Oct 7,1999 to May 31, 2016. The employed econometric

techniques in this study are the generalized autoregressive conditional hetero-

skedasticity (GARCH) and the exponential generalized autoregressive conditional

heteroskedasticity (EGARCH) models. The GARCH and EGARCH results confirm that

terrorism has a significant effect on both the stock market returns and volatility in

Pakistan. In addition, the EGARCH results also conclude that the negative shock (ter-

ror news) creates higher volatility as compared to positive shock (good news) in the

stock market. The outcomes suggest that terror events significantly affect financial

investors in the stock markets. The paper suggests that terror risk is an influential

cognitive factor in describing the stock market returns and volatility. Terror must be

addressed in order to achieve desirable stability in financial markets.

1|INTRODUCTION

Well-developed stock market performs a crucial role in the economic

development and growth of an economy. It serves as an appropriate

tool in mobilizing and the allocating savings between competing uses

which are essential for the growthand efficiency of a nations' economy.

Progressive stock market emulates health and strength of the economy

and works as a barometer for the economic development of a country

(Dagar, 2014). The stock market is highly vulnerable to those factors

which takeplace at once like terrorist activities,financial crisesand coup

in the country. There are various factors which result to stock market

volatilitylike credit policy of the country, inflation, interest rate, volume

of stocks (French, 1980), political situation, herd behaviourand risk atti-

tude among investors, internal development, financial condition, peace

circumstances, loan cost and currency trade rate (Ghufran, Awan,

Khakwani,& Qureshi, 2016; Wiloski,2015). Trade of stocks in the stock

market exhibit high pricevolatility due to therevelation of new informa-

tion occurred withinthe country (Wiloski,2015).

Terrorism is one of the elements to which a stock market is

highly vulnerable because it influences the investor's sentiment

regarding investment. Terrorism is elucidated as a threat or use of

unlawful force and severity to get an economic, political, religious

or social purpose through fright, compulsion or intimidation

(LaFree & Dugan, 2007). It is one of the timeworn phenomena

that plagued humanity for centuries, terrorism not only results in

a human and physical loss but have a worse psychological effect.

All the statistical records of injured, fatalities and ruined result

from terrorist attacks and activities confirm that the psychological

impacts of terrorist activities are spreading each passing day. The

main objectives of terrorism and goal of terrorist are the same

across the worlds, which are to cause damage, ruin the national

assets and resources, create disturbance in the service-based

operation and to get attention around. Terrorist activities create

fear, panic, insecurity and uncertainty in the country (Atr, 2004;

Keeney & Von Winterfeldt, 2010: Aslam & Kang, 2015). It also

results to influence the politic, foreign affairs and economic

Received: 7 March 2020 Revised: 22 June 2020 Accepted: 19 July 2020

DOI: 10.1002/pa.2304

J Public Affairs. 2022;22:e2304. wileyonlinelibrary.com/journal/pa © 2020 John Wiley & Sons Ltd 1of10

https://doi.org/10.1002/pa.2304