Terror Attacks, Foreign Exchange Markets and Class Dynamics

Abstract

This paper examines the effect of major terror attacks of the twenty-first century on the forex market. The “event study” methodology is used to assess whether, following a terror attack, the currency of the country attacked experienced a negative effect. It also examines whether this effect is permanent or transitory and whether there are differences between recent and earlier attacks. Results suggest that earlier events cause substantial negative “event-day” returns for the specific currency, which seem to persist for some days. This is particularly evident in pairs involving the currency of the country attacked and “safe heaven” currencies (e.g. Yen, Swiss Franc). The paper also documents that terror attacks that occurred recently appear to have very little influence on the currency pairs examined, thus suggesting that, over time, market participants have learnt to better assess such events. Given our findings, and particularly the one suggesting that the effects of terror attacks on the foreign exchange market, and hence the economy, are transitory, it would appear that class dynamics are not likely to be affected by them; forex markets appear to be particularly efficient in dealing with such events, absorbing short-term shocks and continuing to function effectively, thus maintaining economic stability.