Risk, Uncertainty, and the Perceived Threat of Terrorist Attacks: The Advisory System that Cried Wolf?

43 Pages Posted: 30 Sep 2007 Last revised: 29 Oct 2008

See all articles by Michael S. Pagano

Michael S. Pagano

Villanova University - Villanova School of Business

T. Shawn Strother

University of Nebraska-Lincoln

Date Written: October 20, 2008

Abstract

Information provided by the U.S. Department of Homeland Security regarding potential terrorist attacks significantly affects the U.S. equity market. When the government raises the perceived threat level, investors' perceptions of risk increase (as measured by the conditional volatility of returns and implied volatility on S&P 500 Index options), but these responses have declined monotonically over time. We also find evidence that informed traders are more active when there is an increased threat of an attack. Thus, the perceived threat of terrorism can affect both equity volatility and the information content of trades but not necessarily the level of aggregate returns.

Keywords: Knightian uncertainty, systematic risk, terrorism, asset pricing, financial markets, GARCH, EGARCHM, volatility expectations, VIX, informed trading, PIN

JEL Classification: G12, G14, G18

Suggested Citation

Pagano, Michael S. and Strother, Timothy Shawn, Risk, Uncertainty, and the Perceived Threat of Terrorist Attacks: The Advisory System that Cried Wolf? (October 20, 2008). 20th Australasian Finance & Banking Conference 2007 Paper. Available at SSRN: https://ssrn.com/abstract=1016901 or http://dx.doi.org/10.2139/ssrn.1016901

Michael S. Pagano

Villanova University - Villanova School of Business ( email )

800 Lancaster Avenue
Villanova, PA 19085-1678
United States
(610) 519-4389 (Phone)

HOME PAGE: http://www90.homepage.villanova.edu/michael.pagano

Timothy Shawn Strother (Contact Author)

University of Nebraska-Lincoln ( email )

Lincoln, NE 68588-0490
United States

HOME PAGE: http://www.unl.edu

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