The determinants of terrorist shocks' cross-market transmission

Purpose - The purpose of this paper is to explore the determinants of the cross-market transmission mechanism for terrorist shocks, focusing on two major terrorist events and 68 national stock markets. Design/methodology/approach - The paper generates daily abnormal returns from a three-factor world asset-pricing model. Abnormal returns are then regressed on proxies of three transmission mechanisms; a world integration channel, a bilateral integration channel, and a liquidity channel. Findings - The findings indicate that terrorism shocks are diffused cross-nationally in a non-uniform manner. This paper finds empirical support for all three channels when considered separately. The bilateral integration channel contains the highest explanatory power since it is found that a third country's trade linkages with the "ground-zero" country explain about 24 percent of the stock market reaction. A country's share in the world trade, a proxy for the world integration channel, is able to explain about 12 percent of abnormal-return variation, while the liquidity channel exhibits the lowest predictive power, with the value of stock trading explaining about 6 percent. A hybrid model, where proxies for all channels are included, shows that only the bilateral trade linkages with the "ground-zero" country are significant determinants of the stock market reaction. Practical implications - Provides evidence useful for portfolio management and authorities' assessment of terrorist shocks' impact on capital markets. Originality/value - It is the first study that investigates the determinants of cross-market transmission of terrorist shocks.