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STUDENT DETAILS

Student name: Trương Nhật Phương Thanh Student ID number: 31211021734

Student name: Trương Bùi Hà Tiên Student ID number: 31211024856
Student name: Bùi Tiến Đạt Student ID number: 31211023661
Student name: Phạm Phú Lộc Student ID number: 31211024881
Student name: Ngô Nguyễn Nguyệt Đình Student ID number: 31211022163

UNIT AND TUTORIAL DETAILS

Unit name: Applied Econometrics Unit number:
Tutorial/Lecturer: Group Project Report Class day and time: AE-DH47ISB-14
Lecturer or Tutor name: Lê Anh Tuấn

ASSIGNMENT DETAILS
Title: Research Project
Length: Due date: April 8, 2023 Date submitted: April 8, 2023

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2
 ABSTRACT
This study investigates the influence of terrorism risk on stock market integration in the
period from 2000 to 2020 among countries in Asia. Given that our statistic includes 252
observations from 12 different regions in Asia, the objective of this investigation is to go
deeper into the effect analysis. According to the baseline result, we perform the White test to
determine whether the errors are heteroskedastic or not. This is a particular testing step that
shows that the model accepts the heteroskedasticity problem. Then, using the robust standard
error to obtain consistent results before running the model. After getting the outcome, we then
discovered that the terrorism risk negatively impacts stock market integration among Asian
countries. Moreover, we can also indicate that, compared to high financial development areas,
low financial development areas experience less of an influence from the terrorism risk on
stock market integration.

Keywords: Terrorism risk, stock market integration, low financial development countries,
high financial development countries, Asia.

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 TABLE OF CONTENTS

I. INTRODUCTION 5
1. Overview of the problem 5
2. Research Gap 5
3. Research Questions 6
4. Research Motivations 6
5. Research Contributions 7

II. LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT 7

1. Terrorism and Terrorism Risk 7
2. Stock Market Integration 8
3. Hypothesis Development 9

III. METHODOLOGY 12
1. Data Collection 12
2. Measuring Terrorism Risk 12
3. Measuring Stock Market Integration 13
4. Baseline Model 13
5. Interaction-terms Model 14

IV. EMPIRICAL RESULTS 15

1. Variable Definitions Table 15
2. Summary Statistics 17
3. Correlation Matrix with Significance Level 17
4. Baseline Results 18
5. Interaction-terms Results 21

V. CONCLUSION 22

VI. REFERENCES 24

VII. APPENDIX 30

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 I. INTRODUCTION

1. Overview of the problem

An economy's ability to expand and flourish economically is greatly influenced by its
stock market. For the expansion and effectiveness of a country's economy, it acts as a suitable
tool for mobilizing and allocating savings between conflicting needs. A country's economic
development can be gauged by the progress of its stock market, which mirrors the economy's
health and strength (Dagar, A., 2014). The stock market is extremely susceptible to
simultaneous events like terrorist activity.
One factor that makes the stock market particularly vulnerable is terrorism since it
affects investor sentiment toward investments. Terrorism is defined as the threat of using
unlawful force and severity to achieve a goal in business, politics, religion, or society through
coercion or intimidation.(LaFree and Dugan, 2007) It is a time-honored phenomenon that has
tormented society for generations. Terrorism not only causes human and physical loss but also
has a negative psychological impact. All records of injuries, fatalities, and property damage as
a result of terrorist attacks and activities demonstrate that the psychological effects of terrorist
operations are spreading by the day.
Attacks by terrorists lead to a decline in investor morale, which in turn puts negative
pressure on stock prices. Terrorism has a negative relationship with the country's economy
because it destroyed the nation's infrastructure, physical assets, and human capital, increased
counterterrorism expenses, increased financial instability, and reduced investor confidence,
which reduced foreign investment and domestic trade. (Barry Johnston and Nedelescu, 2006);
(Jain and Grosse, 2009). The findings (Arin, Ciferri and Spagnolo, 2008); (Chesney, Reshetar
and Karaman, 2011); (Mobarek et al., 2016); (Shahzad et al., 2020) show that some of the
mega terrorist attacks cause significant losses to the most sustainable stock markets around the
world. These studies' findings demonstrate how severely vulnerable the stock market is to
terrorist attacks because of its direct connection to investment security.

2. Research Gap
For the past 10 years, terrorism has increased on a global scale. A significant issue
facing the globe now is terrorism. In-depth studies on the subject of terrorism's economic
effects have been conducted, especially in the wake of the 9/11 terrorist attacks. The study of
how terrorist acts impact stock market performance, however, is still in its early stages.
Karolyi (2006) came to the conclusion that little is yet known about how terrorism affects the

5
economy. The majority of studies have concentrated on a select few catastrophes that have
only happened in developed nations. Since then, the focus has widened, and several studies
have concentrated on long-term terrorist incidents for wealthy nations as well as for nations
other than the United States. There is, however, a dearth of research on the impact of some of
the key elements of terrorist strikes, such as assaults on strategic and civilian targets, and how
they affect market sentiment. Especially, if the stock market serves as a gauge of economic
confidence, it is striking to observe how swiftly it declines following a terrorist attack. Current
empirical research shows how the stock market has changed and how the economy has
expanded.

3. Research Questions
The purpose of this study was to determine the relationships and impacts that terrorism
risk may have on stock market integration among Asian regions in the period from 2000 to
2020. To investigate the connections between terrorism risk and stock market integration, we
have developed 2 research questions and chosen data from many sources to look at the
linkages between them.
● How does terrorism risk impact index returns of the stock market in Asia?
● How does the influence of terrorism risk on the stock market integration in
high financial development countries differ from that in low financial
development countries?

4. Research Motivations
Terrorist attacks have been a serious problem and have caused a high degree of
uncertainty as well as instability for the stock market globally, according to a number of
consistent findings. The effects of terrorism on the capital markets are especially severe in
developing emerging markets (Arin, Ciferri and Spagnolo, 2008). Some studies indicated that
US capital markets were less affected than European and Japanese stock markets due to the
deadly 9/11 terrorist attack (Charles and Darné 2006). Besides, the findings of Kollias,
Papadamou and Stagiannis in 2011 revealed that Athens' stock market was more vulnerable to
terrorist attacks than the London stock exchange. Various terrorist strategies and iterations
have distinct impacts on financial markets around the world (Ahmad et al., 2022). However,
the knowledge regarding the association between terrorism risk and stock market integration
is still vague and requires additional studies. Therefore, this issue motivates us to conduct
research on the influence of terrorism issues on the stock market in Asia market and provide
our empirical studies on this growing literature.

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 5. Research Contributions
The findings of this paper contribute to the new topic which is about terrorism and stock
performance relationship in a global-sized sample, Asia. It can give investors a better view of
the Asian stock market. They could also consider contributory factors of terrorism issues that
lead to stock performance. Our data methodology aids in the clarification of a deeper
understanding of how the terrorism problems affect particular Asian countries in our research.
Due to issue with the legal system, lack of rules, regulations, and processes, server security
difficulties, unstable economies, low literacy rates, a lack of specialized accountants and
auditors, and insufficient financial system infrastructure, not all of Asia’s nations has a stock
exchange (Saddique and Anwar, 2019). Additionally, some nations have stock exchange
markets but lack the presence of terrorist groups and violent terrorist incidents (Sandler,
1995). Hence, we chose to carry out the research in 12 Asian countries that met the two
requirements of having an established stock system and experiencing terrorist issues. There
are two reasons why our study chose the Asia market to examine the hypothesis. First, there
are not many papers about the relationship between terrorism issues and stock performance in
Asia. The result of this study can help Asian countries' governments as a reference to control
the stock market regarding considering terrorism attacks. Second, the evolving terrorist threat
recently has posed a significant challenge to the region’s internal stability in Asia which leads
to negative movement in capital markets (Chalk, Rabasa and Rosenau, 2009). The conclusion
from this paper can benefit both the labor force in the Asian stock market but also
international investors investing in Asia.

II. LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT

1. Terrorism and Terrorism Risk

Terrorism, in contrast to homicide, is a frightening type of repetitive violent action
conducted for irrational, criminal, or political reasons by (semi-) clandestine individuals,
groups, or state actors. The immediate casualties are not the prime targets of the violence. The
instant victims of crime are usually selected from a target party either arbitrarily (opportunity
targets) or carefully (representative or symbolic targets) as message generators.
Communication processes based on threats and attacks between a terrorist group, its victims,
and the main aim (audiences), rendering them objects of fear, demand, or attention,
determined by whether propaganda, intimidation, or compulsion is desired (Weinberg,
Pedahzur and Hirsch-Hoefler, 2004). From a socio-historic and politico-economic perspective,

7
7 types of terrorism are seen: Revolutionary Terrorism, Sub Revolutionary Terrorism,
Establishment Terrorism, Nationalist Terrorism, Religious Terrorism, State-Sponsored
Terrorism, Inter-State or International Terrorism, and Group Terrorism (Michael, 2007).
Terrorism Risk is one of the most pressing problems confronting countries all over the
globe. It has an impact on nations by destroying economies, shaking markets, disrupting
capital allocation, slowing economic growth, ruining infrastructure, reducing foreign
investment, aiming political, corporate, and military personnel, resulting in numerous injuries
and deaths, lowering exports, raising enterprise danger, growing the security risk, and
controlling investor thoughts and feelings. Acts of terrorism raise the level of ambiguity and
danger. Uncertainty cannot be calculated, but the risk from terrorism can be measured (Kousar
et al., 2019).
Despite the scarcity of research on the topic, terrorism has a substantial effect on
national stock markets and economic growth. In the context of stock market returns, the
number of suicide attacks, the number of terrorist attack fatalities, terrorist attacks in major
cities and capital cities, the distance between the terrorist attack and the capital city, the
amount of property damaged as a result of the terrorist attack, and the nationality of the
terrorist attack victims are all examined (Ahmad et al., 2022). Terrorism's threat has a
significant impact not only on Asian economies, but also on investments, financial
organizations, and foreign commerce. The dread of terrorism has been shown to have an
influence on stock exchanges, either directly or indirectly (Narayan, Le and Sriananthakumar,
2018).

2. Stock Market Integration

An established concept of integration for stock markets is based on the principle of one
price. From the standpoint of asset pricing, equities with comparable future cash flow risks
should be valued equally irrespective of where they are quoted (Adler, 1995; Bekaert &
Harvey, 1995). So, stock market links are not a necessary requirement to demonstrate the
applicability of the law of one price. Asset pricing models, which establish a basic former
framework, should provide the foundation for evaluations of market integration. Integration of
the global stock market must be compared to a global portfolio or a list of risk variables.
Asia's stock markets have effectively integrated, and the region's proportion of equity
investments is growing (Chien et al., 2015). Although several studies have looked at the
regional integration of Asian stock markets, there is not much important literature on the
topic. The overall features of the local stock market have a significant impact on investors'

8
asset allocation and risk management (Anginer, 2014; Sehgal et al., 2018). The development
of trade ties and financial markets in Asia promotes regional stock market integration in
addition to its global integration (Caporale et al., 2019). Park (2013) presents evidence of how
regional and international changes in stock and bond market returns might impact financial
markets in emerging Asia. Regulational developments in financial markets across Asia are
indicative of the rise of the capital market, a significant part of industrial credit for Asian
businesses (Lipinsky and Ong, 2014). In spite of this, evidence from several research,
including those by Singhania and Prakash (2014), Karim and Majeed (2010), and Ibrahim
(2005), disprove the correlation between Asian stock markets.
Several of the research mentioned above looked at financial integration in Asia before
the 2008 global financial crisis. International commerce and money movements were severely
disrupted by the global financial crisis of 2008, which was the worst economic disaster since
World War II. The financial integration of markets has undergone substantial modifications
since the financial crisis (Bakry and Al-Muhammad, 2018). During the Asian financial crisis,
there has been considerable intraregional consolidation in a number of partnerships in the
commodity markets. Caporale et al. (2019) explore the interconnectedness of international and
regional stock exchanges in Asia at both the volume and distribution level using the
Phillips-Sul tests for the 1998–2018 period. They found that although confluence has slowed
since the crisis, Asian stock markets still seem to be interconnected globally and locally.

3. Hypothesis Development
Terrorism has grown across the world over the previous decade, and it now ranks among
the most significant worldwide concerns. Following the 9/11 terrorist attacks, several
researchers have focused on the economic consequences of terrorism. Yet, research on the
influence of terrorist acts on stock market returns remains in its early stages.
Numerous researchers studied how terrorist incidents affect an economy's state:
- Research by Buesa et al. (2007), Gaibulloev and Sandler (2009), and Abadie and
Gardeazabal (2008) revealed that terrorism had a detrimental effect on economic
development.
- According to research by Bautista (2003), Nguyen and Enomoto (2009), Nikkinen et
al. (2008), and Fernandez (2007), terrorist attacks have a severe effect on stock market profits
and make them unpredictable.
- Berrebi and Klor (2010) used event research methods to investigate how terrorism
affects the stock price of Israeli firms. In short, they came to the conclusion that businesses

9
engaged in military, or antiterrorism security measures have a favorable result and those
engaged in non-related activities have a worrying growth. The findings indicate that terrorist
attacks have a detrimental impact on equities and stock markets.
- A study was carried out by Alam in 2012 to examine the connection between terrorist
incidents and the KSE100 index. They discovered that Indonesia's degree of casualty effect
was -0.0037, Israel's represented -0.0027, and Turkey's was indeed -0.0018. They claim that
when applying the terrorist GARCH model, the mean coefficient becomes significant for all
of the nations examined and that the fluctuation of the terror index affects negative stock
returns.
- According to research by Karolyi and Martell (2006), terrorist attacks have a major
adverse impact of 0.83 percent on stock prices, which translates to a loss of an estimated $401
million in market capitalization per assault for each business.
- Eldor and Melnick (2004) also investigated how 639 terrorist incidents affected Israeli
stock market prices and currency exchange rates. When leading government officials are
targeted for homicide, the stock market falls; when senior military commanders are targeted, it
increases.
- In a related research, Aslam and Kang (2014) estimated the effect of 300 terrorist
attacks over a 12-year period on the Karachi stock market using event study methods. The
KSE-100 index results were significantly negatively impacted by terrorism, according to the
authors. Also, they discovered that the influence varies based on the region and the
seriousness of the terrorist incidents. The negative effect on the stock market increases with
the intensity of the terror incident (more fatalities or suicides) (Eldor et al., 2012).
Additionally, given the rarity of revolutions and wars in wealthy nations, capital flight
may be a factor in these economies' ability to sustain expansion (Blomberg, 2005). Yet,
developing economies frequently experience socio-political unrest, which makes the climate
for investors unstable. As a result, investment began to increasingly shift from growing
countries to safer markets. Empirical findings support the prospect theory, which holds that
investors are more motivated to pursue profits than to buffer against losses. Investors' greater
risk sensitivity causes them to relocate their money to safer locations. Due to higher business
expenses, transaction costs connected with buying property, and danger associated with the
destruction of traded property, terrorism also has a negative impact on multilateral trade
between nations (Frey et. al, 2007). Llosa and Tavares (2011) also discussed the detrimental
consequences of terrorism on economic growth. According to studies by Blomberg and Hess

10
(2006); and Walkenhorst and Dihel (2006), acts of terrorism have a negative impact on
economic growth.
Due to all of these related empirical articles, we can make the following prediction:
H1: The threat of terrorism has a detrimental impact on stock market integration
among Asian countries.
H2: The negative influence of terrorism risk on stock market integration is
particularly prominent in high financial development nations.

Figure 1: Conceptual Framework

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III. METHODOLOGY

1. Data Collection
We collect the yearly index ratio of the respective stock exchanges from The World
Bank. We chose thirteen Asian nations with a developed stock market as well as the biggest
frequency of rather catastrophic terrorist occurrences. Based on these two criteria, the 13
nominated nations are India, Bangladesh, Philippines, Indonesia, Sri Lanka, Thailand,
Pakistan, Russia, Israel, Saudi Arabia, Nepal, Turkey, and China. The nations that were
omitted either did not have solid stock markets or had a relatively low incidence of
catastrophic terrorist incidents.
We collect country-level data from many sources, then consolidate and store it as a
panel database in Microsoft Excel. We collect the terrorist events (event date, attack type,
target types, and human loss) for the period from 2000 to 2020 using The Global Terrorism
Database developed by the University of Maryland. We exclude attacks that were attempted
but not successfully carried out. We start with 32,259 observations of terrorist occurrences,
which we then aggregate into 252 observations organized by year and country.
Our final sample includes 252 observations from 12 countries throughout the period
from 2000 to 2020.

2. Measuring Terrorism Risk

We measure the Terrorism Risk by the total number of fatalities and injuries resulting
from the attacks within the observed year. Even though other factors, such as changes in
investor sentiment, perceptions of risk, or government policy responses, may also play a role,
these characteristics are largely impossible to quantify and are not publicly available.
Furthermore, Nitsch and Schumacher (2004) argue that the number of terrorist attacks and
fatalities can be a useful measure of terrorism risk, and find that they have a negative impact
on international trade. The yearly number of fatalities and injuries (TERROi,t ) is calculated:

where TERROi,t is the total number of fatalities and injuries for period t, FATAi,t is the
number of fatalities for period t, and INJUii,t is the number of injuries for period t.

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 3. Measuring Stock Market Integration
According to Caporin and McAleer (2011), using the log of an index may be more
appropriate for modeling financial volatility, as it takes into account the percentage changes in
asset prices. The yearly logarithmic index (Ri,t ) is calculated:

where Ri,t is the index's return for period t, Ii,t is the index's value at the end of period t, and
Ii,t-1 is the index's value at the end of period t-1.

4. Baseline Model

where dependent variable, StockMarketIntegrationi,t , is the yearly logarithmic index Ri,t that
indicates the annual percentage change in the index value for country i in year t.
TerrorismRisk, measured by TERROi,t , captures the total number of fatalities and injuries
resulting from terrorism for country i in year t, and we take the natural logarithm to transform
the variable TERROi,t into variable log (Terrorism Risk)i,t.
CountryControli,t is the set of country-level control variables, including REGULATORY
QUALITY, MARKET VOLATILITY, INFLATION RATE, INTEREST RATE, EXCHANGE
RATE VOLATILITY, TRADE OPENNESS, and FOREIGN DIRECT INVESTMENT.
REGULATORY QUALITY is a measure of the effectiveness of a country's regulatory
framework in promoting economic growth and development. The studies of Hansen and Rand
(2006) and Bekaert, Harvey, and Lundblad (2006) demonstrated the significance of regulatory
quality in determining stock market integration and financial liberalization. By including
regulatory quality as a control variable, the study can better isolate the effect of terrorism risk
on stock market integration. Similarly, MARKET VOLATILITY can affect investment
decisions and economic outcomes, with higher levels of volatility leading to increased

13
uncertainty and reduced investment (Shiller, 2014). INFLATION RATE is an important
control variable in economic research because it reflects the rate at which prices are increasing
over time, which can have negative effects on economic growth and stability (Blanchard,
Giovanni Dell 'ariccia and Mauro, 2010). INTEREST RATES, which reflect the cost of
borrowing or the return on savings, can have a significant impact on investment decisions,
inflation rates, and exchange rates, all of which can influence economic outcomes (Bernanke,
2011). The article by Hajilee and Nasser (2014) supports the inclusion of EXCHANGE RATE
VOLATILITY as a control variable, as it has been found to have a negative impact on stock
market development in emerging economies. Additionally, TRADE OPENNESS, which refers
to the degree to which a country participates in international trade, can have significant effects
on economic growth, productivity, and income distribution (Dollar and Kraay, 2004). Finally,
FOREIGN DIRECT INVESTMENT perhaps more than all other international economic
activities, has the potential to link economies, thereby integrating world stock markets (Shi et
al., 2016).
We include country-fixed effects and year-fixed effects in a regression model to control
for unobserved heterogeneity that varies across entities or time periods, thereby reducing bias
and improving the accuracy of the estimates. As Bertrand, Duflo, and Mullainathan (2004)
point out, including fixed effects in a regression model can be an effective way to address
endogeneity and isolate the effects of the independent variables on the dependent variable. By
including these fixed effects, we can examine country- or time-specific effects that may not be
captured by the independent variables alone, and gain a more nuanced understanding of the
relationship between the independent variables and the dependent variable.

5. Interaction-terms Model
In order to investigate the relationship between stock market integration and terrorism
risk in countries with high and low financial development, we consider the following
model specification:

In detail, the coefficient off the interaction term high_FD*Log (Terrorism Risk)i,t will
explain if the effect of terrorism risk is different in countries with high financial development

14
 compared to countries with low financial development. The term would be interpreted as the
difference in stock market integration led by the coordination of terrorism risk and financial
development index.

IV. EMPIRICAL RESULTS

1. Variable Definitions Table

Variables Short Description Unit of Source

name measurement

Terrorism Risk TR The total number of fatalities and People Global

injuries resulting from the attacks Terrorism
within the observed year. Database -
START.umd.edu

Stock Market SMI Measured by dividing the index % World Bank

Integration value at the end of period t by the Database
index value at the end of period
t-1.

Financial FD Includes the size of the financial No unit International

Development Index
sector relative to the economy, Monetary Fund
depth of the financial system, Database
access to financial services,
efficiency of financial
intermediation, and stability of the
financial system.

Regulatory Quality RQ Measure the effectiveness and Point World Bank

efficiency of a country's regulatory Database
framework in promoting economic
growth and development.

Market Volatility MV The CBOE Volatility Index (VIX) No unit Federal Reserve
Index - a financial index that measures Economic Data |

15
 the market's expectation of FRED | St.
near-term volatility based on the Louis Fed
prices of options on the S&P 500
index.

Inflation Rate INFR The percentage change in the price % WorldData

level of a basket of goods and Database
services over time.

Interest Rate INTR The percentage of the loan amount % World Bank
that must be paid as interest over a Database
specified period of time.

Exchange Rate ERV Measure the amount of uncertainty LCU per US$ World Bank
Volatility or risk associated with exchange Database
rate movements. Volatility in
exchange rates is driven by various
factors, such as economic and
political events, market sentiment,
and central bank policies.

Trade Openness TO Trade-to-GDP ratio: This measures % World Bank

the value of a country's exports Database
plus imports as a percentage of its
GDP. A higher ratio indicates a
more open economy.

Foreign Direct FDI Calculated by subtracting the Current US$ World Bank
Investment outflows of FDI (money that Database
leaves the country for investment
in other countries) from the
inflows of FDI (money that comes
into the country from other
countries for investment).

16
 2. Summary Statistics

The descriptive statistics summary of the researched variables are shown in the table
above. For the dependent variable, stock market integration, it has a mean of 5.909 and a
standard deviation of 20.169. The range of terrorism risk is from 2 to 50950, which indicates
that terrorism unevenly took place in 12 examined countries throughout the tested period.
Financial development index, with the average rate of 0.416, we come to the conclusion that
countries having higher indexes are considered to be high financial development nations, the
rest will be low financial development. The inflation rate and interest rate have a mean of
6.032 and 4.798, respectively, which are quite high for the economic structure of one region.
The standard deviations of regulatory quality, market volatility index, exchange rate volatility,
and trade openness are 0.518, 10.699, 3032.514, and 25.552, separately, demonstrating that
these variables vary significantly. With the median of 6.23e+10 in foreign direct investment,
these countries show a high potential in this sector.

3. Correlation Matrix with Significance Level

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 The table above, as can be seen, shows the coefficient correlation between the research's
explanatory variables, specifically the connection between the main independent variable and
the control variables. The results clearly illustrate that terrorism is associated with the
majority of the control variables, with the exception of market volatility and interest rates,
which have insignificant correlations. For example, the correlation between terrorism and
stock market integration is -0.337. This indicates that these two variables are slightly
negatively correlated, and the symbol (***) means that this correlation is significant at 1%.
Therefore, it suggests that the higher the rate of terrorism, the lower the rate of stock market
integration. Besides that, we find a significant and positive association between terrorism and
inflation rates, which implies that nations with higher rates of terrorism also tend to have
higher rates of inflation. Therefore, we can draw the conclusion that multicollinearity is not
conceivable based on our analysis.

4. Baseline Results

The White test results performed that the P-value is 0.000, which is insignificant
compared to 1%. Therefore, based on homoscedasticity, the null hypothesis is rejected.
According to the research, the alternative hypothesis that the model allows for
heteroskedasticity is thus supported. When running the models in order to obtain accurate
findings, the robust standard error is utilized since heteroskedasticity may lead to imprecisely
calculated standard errors, which renders confidence intervals and hypothesis tests unreliable.

18
 The results of the econometric model's baseline analysis are presented in Table 4,
indicating the impact of terrorism risk rate on stock market integration. The study uses robust
standard errors to control for heteroskedasticity, with the inclusion of year fixed effects and
country fixed effects in column (1), while column (2) also includes country-level control
variables, country dummies, and time dummies. The findings indicate that the coefficients on

19
terrorism risk are consistently negative and statistically significant at the 1% level across both
columns, even after adjusting for the variables in the model. Specifically, in column (2), the
coefficient on terrorism risk is -5.984, indicating that a 1% increase in terrorism risk leads to a
5.984% reduction in stock market integration, holding all other variables constant. The results
provide strong support for hypothesis H1, suggesting that the threat of terrorism has a
detrimental impact on stock market integration in Asian countries. Moreover, the high
significance of the coefficients on terrorism risk highlights the importance of considering this
factor in analyzing the behavior of stock markets in the region.

Alongside the statistically significant coefficients on the main independent variable,

there are also insignificant coefficients observed on control variables such as Regulatory
Quality, Market Volatility, Inflation rate, Interest Rate, Exchange rate Volatility, Trade
Openness, and the logarithm of Foreign Direct Investment. To evaluate whether these control
variables collectively hold significance, an F-test is conducted. As shown in Table 5, the
p-value equals 0.0159, which is less than the 5% threshold. Therefore, it can be inferred that
although the insignificant control variables do not exhibit significance individually, their joint
impact on economic complexity is statistically significant.

20
 5. Interaction-terms Results

We are now considering whether the countries which have high or low financial
development have an influence on the relationship between our two main variables, which are
stock market integration and terrorism risk. The above table shows the empirical results of
the interaction terms between a dummy variable for high financial development/low financial
development countries and the main explanatory variable, the Log (Terrorism Risk). Similar to
the results of the basic model, the robust standard errors are in parentheses and used to solve
heteroskedasticity. As can be seen in the table above, the first column just consists of our main
variables and the interaction term without taking into account any fixed effect. For the other
three columns, all control variables are included while the fixed effects are different. All the
coefficients of the interaction term high_FD*Log(Terrorism risk) are negative and statistically
significant so the results are reliable. In particular, as reported in column (1) in the table
above, the coefficient on high_FD*Log(Terrorism risk) is -5.703 (standard error equals
-1.479), highly significant at 1%. Regarding column (4), when including year fixed effects
and countries fixed effect, we receive a highly significant and negative coefficient on the

21
interaction term high_FD*Log(Terrorism risk), which equals -7.513 (standard error equals
1.476) and even the R-squared is .5136, which is much higher than the column (1).
Based on the results, and the result that terrorism risks negatively affect stock market
integration, we then indicate that compared to countries with low financial development, the
impact of the terrorism risk on stock market integration is more pronounced in countries with
high financial development. In terms of economic significance, with a one percentage point
increase in the terrorism risk, the stock market integration of countries with high financial
development is 7.513 units lower than that of countries with low financial development,
stating that the negative impact of the terrorism risk on stock market integration is
stronger/more pronounced for countries with high financial development.

V. CONCLUSION

Terrorism is one of the elements influencing the national economy since it produces
uncertainty, and financial instability, reduces foreign investment, and, most importantly,
shakes investor confidence, causing unease and volatility in the stock market. Our research
examines the impact of terrorism on stock market integration in Asian countries between 2000
and 2020. The research findings make a significant contribution to the paper on the
relationship between stock performance and terrorism worldwide, especially in Asia.
Investors may gain a better understanding of the Asian stock market as a result. Overall, the
results of this study are important because they partially corroborate what has been written in
the literature and show that terrorist strikes have an incalculable effect on the stock market.
Our research indicates that the risk of terrorism has a negative influence on the
integration of the capital markets in Asia. Additionally, we may conclude that low financial
development locations, as compared to high financial development areas, face less of an
impact from the terrorism risk on stock market integration.
● How does terrorism risk impact index returns of the stock market in Asia?
Since there haven't been many studies done on this subject, experts frequently
concentrate on the underlying reasons why terrorism is growing in Asia and how it affects the
region's stock markets. The stock markets have been adversely impacted by 2/3 of terrorism
attacks. For instance, the stock markets of Israel, Indonesia, and Thailand were studied by
Arin et al. (2008) to see how terrorist acts influenced them. They discovered that both the
stock markets' performance and volatility were impacted.

22
 ● How does the influence of terrorism risk on the stock market integration in
high financial development countries differ from that in low financial
development countries?
High terrorism risk is associated with poor financial performance and high credit risk
for banks located in high-income-generating countries. When banks in low-income countries
are targeted by terrorists, they appear to have low credit and liquidity risks. Furthermore, this
group of banks has consistently demonstrated strong financial performance in terms of cost
efficiency and profitability. (Elnahass et al, 2022). Therefore, superior financial performance
and improved cost-effectiveness for banks that face a high risk of terrorism.

23
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VII. APPENDIX

Appendix 1: Asia Financial Development Index (FD)

Note: Google Sheets Link for the FD Index data verification. Data

Appendix 2: High and Low Financial Development Countries

High Financial Development Low Financial Development

Countries Countries

China, Israel, Russia, Turkey, Saudi Bangladesh, India, Indonesia, Pakistan,

Arabia, Thailand. Philippines, Sri Lanka.

Appendix 3: All Variables Data

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31
32
33
34
35
Note: Google Sheets Link for the Variables data verification. Data

36