Thursday, April 6, 2006

How Financial Markets React to Shocks (from

For some reason, I've been getting a number of questions lately on the effect of 9-11 on markets. And then, just the other day, I see this analysis on It looks at a study titled "Updating Expectations: An Analysis of Post-9/11 Returns", done by
Jarl Kallberg and Crocker H. Liu (both at New York University) and Paolo Pasquariello (at the University of Michigan).

The study examines how the stock prices of Real Estate Investment Trusts (REITS) with holdings in New York reacted to 9-11. It's an interesting question, because it's not immediately clear before the fact whether these REITS would benefit from the removal of rental units from the market (thereby driving up rental rates), or would be hurt by a possible NYC economic slowdown. Here's what they found:

  1. REIT stock prices initially went up significantly. Prices of REITS with exposure to the NYC market outperformed a broader REIT index by about 4% ion the first day that the market reopened after 9-11.
  2. However, when the increased operating performance didn't materialize, insiders of these REITS were the first to notice, and they "voted with their feet" (i.e. they started selling off their shares.
  3. Next, analysts started revising their forecasts of these firms downwards.
  4. Only later did the stock price of the REITS catch up with the lowered expectations of the more informed insiders and analysts.
Click here for a PDF version of the paper.

A very cool piece, both because of the way it shows how markets react to an unexpected shock, and because it highlights the ways different parties process information. It would be a great piece to discuss in a class module on market efficiency. Luckily, I teach that section next week.

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