The Impact of Unsuccessful Pirate Attacks on Financial Markets: A Confirmation of Reputation Building Theory

Abstract

Pirates are organized criminals and their behavior may be explained based on sound economic theory. This paper tests the theory of Leeson (2012), who explains the behavior of pirates based on signaling and reputation building theories. In 2010 alone, Somali pirates attempted 1,181 hijackings in and around the Gulf of Aden. Some of these attacks were on oil transport vessels which led to multiple short-term disruptions of oil supply out of the Middle East, whereas others were on tourism vessels. Between 2006 and 2010, pirates brought in roughly $200 million annually which corresponds to nearly one-fourth of the total Somali GDP. While hundreds of attacks were successful, many more were unsuccessful. Reputation building theory states that unsuccessful attacks serve to build reputation for the pirates. We find that expectations of further pirate attacks may negatively affect oil prices and decrease potential returns in financial markets. Our findings therefore support the reputation building theory.