The Economic Cost of Terrorism and Natural Disasters: A Deeper Analysis of the Financial Markets of Pakistan

Abstract

Do natural disasters and terrorism affect the financial markets of Pakistan? We aimed to answer this question by studying a large data-set of stock returns of Pakistani financial markets with respect to natural disasters and terrorist activities. Two methods are used for that purpose i.e. event study and nonlinear GARCH (Generalized Autoregressive Conditional Heteroskedasticity) estimation. The event study methodology used to analyze daily, weekly, and monthly stock returns of KSE-100 (Karachi Stock Exchange-100 index), Banking, and Insurance sectors. We calculated the abnormal returns with the help of market adjusted return model. Findings reveal that terrorist events have a statistically significant negative impact on banking and insurance sector returns, while insignificant impact on KSE-100 index. Natural disasters have an insignificant impact on stock market returns, with the exception of floods which showed a significant impact on bank returns but remained insignificant for insurance and stock market returns. Earthquakes showed a negative effect on the stock market returns whilst no significant impact has shown for insurance and banks’ returns. Whereas, nonlinear estimation such as GARCH model is applied to model the volatility and the influence of terrorist events on conditional variance for three mentioned stock market indices. Moreover, GARCH model indicates the higher volatility during 2000-2010, which is decreasing towards the end of sample period. The higher volatility periods in financial markets correspond to higher number of terrorist attacks in the country and instability in the political environment.