VOLATILITY TRANSMISSION PATTERNS AND TERRORIST ATTACKS
ABSTRACT The objective of this study is to analyze volatility transmission between the US and Eurozone stock markets considering the effects of the September 11, March 11 and July 7 financial crises. In order to do this, we use a multivariate GARCH model and take into account the asymmetric volatility phenomenon, the non-synchronous trading problem and the crises themselves. Moreover, a graphical analysis of the Asymmetric Volatility Impulse-Response Functions (AVIRF) is introduced, which takes into consideration the crisis effect. Results suggest that there is bidirectional and asymmetric volatility transmission and show the different impact that terrorist attacks had on both markets. El objetivo de este estudio es analizar la transmisión de volatilidad entre los mercados de EEUU y la Eurozona, considerando el efecto de los ataques terroristas del 11 de septiembre, 11 de marzo y 7 de julio. Para ello, se utiliza un modelo GARCH multivariante, teniendo en cuenta el fenómeno de la volatilidad asimétrica y el problema de la negociación no simultánea. Asimismo, también se propone un análisis gráfico de la transmisión de volatilidad a través de funciones impulso-respuesta en volatilidad asimétricas (AVIRF) y que consideran la existencia o no de crisis financieras. Los resultados sugieren que la transmisión de volatilidad es asimétrica y bidireccional y muestran que los ataques terroristas tuvieron un impacto diferente en los mercados bursátiles considerados.
Electronic copy of this paper is available at: http://ssrn.com/abstract=963632
Volatility transmission patterns and terrorist attacks*
Francisco J. Climent
This version: December 2006
The objective of this study is to analyze volatility transmission between the US and
Eurozone stock markets considering the effects of the September 11, March 11 and July 7
financial crises. In order to do this, we use a multivariate GARCH model and take into account
the asymmetric volatility phenomenon, the non-synchronous trading problem and the crises
themselves. Moreover, a graphical analysis of the Asymmetric Volatility Impulse-Response
Functions (AVIRF) is introduced, which takes into consideration the crisis effect. Results
suggest that there is bidirectional and asymmetric volatility transmission and show the different
impact that terrorist attacks had on both markets.
JEL Classification: C32; F30; G15
Keywords: International financial markets; Stock market crisis; Multivariate GARCH; Volatility
* All authors: Universitat de València. Facultat d’Economia. Departament d’Economia Financera i Actuarial.
Corresponding author: Pilar Soriano. Universitat de València. Facultat d’Economia. Departament d’Economia
Financera i Actuarial. Avda. Tarongers s/n 46022 València (Spain). E-mail: Pilar.Soriano-Felipe@uv.es
Electronic copy of this paper is available at: http://ssrn.com/abstract=963632
On September 11, 2001, March 11, 2004 and July 7, 2005, the cities of New York, Madrid
and London experienced respectively devastating terrorist attacks. These attacks had an influence
over several economic variables and they obviously affected financial markets. Taking into
account the increasing global financial integration, an important question arises: How did these
terrorist attacks affect interrelations between financial markets?
The main objective of this study is to analyze how volatility transmission patterns are
affected by stock market crises. Moreover, we compare the different reactions of the markets to
the particular terrorist attacks considered. In order to do this, we use a multivariate GARCH
model and take into account both the asymmetric volatility phenomenon and the non-
synchronous trading problem. In our empirical application, we focus on stock market crises as a
result of terrorist attacks and analyze international volatility transmission between the US and
Eurozone financial markets.
It must be highlighted that most existing studies on spillovers between developed countries
focus on individual countries such as US, Canada, Japan, UK, France and Germany1. As far as
we know, there are no many articles analyzing volatility transmission patterns between the US
and the Eurozone as a global market. Moreover, this paper will be the first one to take into
account the non-synchronous trading problem and to use a sample period that includes the
September 11, March 11 and July 7 terrorist attacks.
As far as we know, no paper has analyzed until now the effects of the attacks of March 11
and July 7. Moreover, few studies have examined the effects of the attacks of September 11 on
1 See Koutmous and Booth (1995), Karolyi (1995), Karolyi and Stulz (1996), Darbar and Deb (1997), Ramchand
and Susmel (1998), Brooks and Henry (2000), Longin and Solnik (2001), Martens and Poon (2001) and Bera and
Kim (2002), inter alia.
financial markets and they focus on the economy as a whole2 or in different concrete aspects of
the economy. For instance, Poteshman (2006) analyzes whether there was unusual option market
activity prior to the terrorist attacks. Ito and Lee (2005) and Blunk et al. (2006) assess the impact
of the September 11 attack on US airline demand. Glaser and Weber (2006) focus on how the
terrorist attack influenced expected returns and volatility forecasts of individual investors. Chen
and Siems (2004) investigate if terrorist and military attacks (including the September 11 attack)
are associated with significant negative abnormal returns in global capital markets. Finally,
Choudhry (2005) investigates the effects of the September 11 attack and the period after it on the
time-varying beta of a few companies in the US. However, none of them analyzes volatility
transmission patterns and how they have been affected by the event. As far as we know, the only
papers that analyze changes in interrelations between stock markets are Hon et al. (2004) and
Mun (2005), but they test whether the terrorist attack resulted in a change in correlation across
global financial markets. We try to answer the following question: Were there differences in the
reaction of the US and Eurozone stock markets to the different terrorist attacks considered? In
order to do so, we propose a new version of the Asymmetric Volatility Impulse Response
Functions (AVIRF) which takes into account stock market crises.
When studying asset price comovements and contagion between different financial markets,
an important fact to take into account is the trading hours in each market. In the case of partially
overlapping markets (like US and the Eurozone), a jump in prices can be observed in the first
market to open when the second one starts trading, reflecting information contained in the
2 A special issue of the Economic Policy Review of the Federal Reserve Bank of New York (2002, Volume 8,
Number 2) analyzes general economic consequences of September 11. A special issue of the Journal of Risk and
Uncertainty (2003, Volume 26, Numbers 2/3) deals with the risks of terrorism with a special focus on September 11.
A special issue of the European Journal of Political Economy (2004, Volume 20, Issue 2) deals with the economic
consequences of terror.
opening price. Therefore, this could make volatility increase in this first market. Moreover, as
suggested by Hamao et al. (1990), a correlation analysis between partially overlapping markets
using close to close (C-C) returns could produce false spillovers, both in mean and volatility.
This is so because it is difficult to separate effects coming from the foreign market from those
coming from the own market while it remains closed.
There are several solutions in order to artificially synchronize international markets. First
of all, in the case of US, information transmission with other markets can be analyzed through
American Depositary Receipts (ADRs), which will share trading hours with the US market. The
problem is that there are no many ADRs, they are not actively traded and there are
microstructure differences between the North American stock market and that from the original
country [see Wongswan (2006)]. Some studies, such as Longin and Solnik (1995) and Ramchand
and Susmel (1998), use weekly or monthly data in order to avoid the non-synchronous trading
problem. However, the use of low frequency data leads to small samples, which is inefficient for
multivariate modeling. On the other hand, some studies, such as Hamao et al. (1990) and
Koutmos and Booth (1995), use daily non-synchronous open-to-close and close-to-open returns.
Nevertheless, these studies cannot distinguish volatility spillovers from contemporaneous
correlations. Finally, Martens and Poon (2001) use 16:00-to-16:00 synchronous stock market
series in order to solve this problem. By doing this, they find a bidirectional spillover between
US and France and between US and UK, contrary to previous studies that only found volatility
spillovers from US to the other countries.
This study innovates with respect the existing literature in two ways. First, we study
volatility transmission between US and the Eurozone using a sample period including the
terrorist attacks occurred in New York, Madrid and London. As far as we know, these terrorist
attacks have not yet been included in any paper analyzing volatility transmission in international
markets. Second, we introduce a new version of Asymmetric Volatility Impulse Response
Functions which takes into account stock market crises.
The rest of the paper is organized as follows. Section 2 presents the data and offers some
preliminary analysis. Section 3 deals with the econometric approach and introduces the AVIRF
with crises. Section 4 presents the empirical results and, finally, Section 5 summarizes the main
The data consists of simultaneous daily stock market prices recorded at 15:00 GMT time for
the US (S&P500 index) and the Eurozone (EuroStoxx50 index). At that time, the European
markets are about to close and the US market has just started trading. We use stock market prices
recorded at 15:00 GMT time, at the midpoint of the overlapping hours, in order to avoid the use
of index prices recorded exactly at the open (US) and close (Eurozone) of trading.
The data is extracted from Visual Chart Group (www.visualchart.com) for the period
January 18, 2000 to January 25, 2006. When there are no common trading days due to holidays
in one of the markets, the index values recorded on the previous day are used.
Each terrorist attack considered had a different effect on financial markets. If we focus on
the September 11 attack, both price indexes reached their minimum level on September 21. In
the Eurozone, the EuroStoxx50 fell by 6.7% the day of the attack and between September 11 and
September 21 was down 17.9%. The New York Stock Exchange did not open until September 17
and fell by 5.1%. Between that day and September 21, the S&P 500 decreased by 12.3%. In
contrast with the effects of the September 11, the March 11 terrorist attack affected less both
markets. The EuroStoxx50 decreased by 3.1% the day of the attack and, at the end of that month,