How do stock markets and bond markets in a country behave in response to terrorist attacks?

We study the effects of terrorist attacks (as exogenous shocks) on equity returns, bond returns, and the correlation between the two. One would expect terrorism to cause (or at least, Granger cause) a short-term negative response in equity returns in the affected country, most likely due to increased risk perception. This is not entirely a new question; similar ideas have been published before (Chen & Siems 2004, Charles & Darne 2006). However, past studies have focused mostly on equity markets in major developed countries, with fewer papers examining equities in developing countries or bonds. In this paper, we show that the best predictor of equity market response is the number of fatalities caused by a terrorist attack, and that the best predictor of bond market response is the mean equity market return prior to the attack. We also show that equity markets and bond markets move together in response to terrorist attacks.