Does Terrorism Affect the Stock-Bond Covariance? Evidence from European Countries

Abstract

Using daily stock and bond returns data from four European countries-France, Germany, Spain, and Great Britain-that have been the victims of significant terrorist activity, this study addresses the issue of whether transnational and/or domestic terrorist attacks have affected in any significant manner the time-varying stock bond covariance, their returns, and their variances. Stock and bond markets can be influenced and determined not only by the usual array of macroeconomic factors but also by security shocks, such as a terrorist incident, that have the potential to affect investors' sentiment and portfolio allocation decisions. The issue at hand is addressed using a VAR(p)-GARCH(1,1)-in-mean model, and the results reported herein indicate that terrorist attacks trigger a flight-to-safety effect primarily in France and Germany and to a smaller degree in Great Britain and Spain.