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Risk Assessment Based on Financial Data: Market Response to Airline Accidents

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  • Robin L. Dillon
  • Blake E. Johnson
  • M. Elisabeth Patè‐Cornell

Abstract

The risk of catastrophic failures, for example in the aviation and aerospace industries, can be approached from different angles (e.g., statistics when they exist, or a detailed probabilistic analysis of the system). Each new accident carries information that has already been included in the experience base or constitutes new evidence that can be used to update a previous assessment of the risk. In this paper, we take a different approach and consider the risk and the updating from the investor's point of view. Based on the market response to past airplane accidents, we examine which ones have created a “surprise response” and which ones are considered part of the risk of the airline business as previously assessed. To do so, we quantify the magnitude and the timing of the observed market response to catastrophic accidents, and we compare it to an estimate of the response that would be expected based on the true actual cost of the accident including direct and indirect costs (“full‐cost information” response). First, we develop a method based on stock market data to measure the actual market response to an accident and we construct an estimate of the “full‐cost information” response to such an event. We then compare the two figures for the immediate and the long‐term response of the market for the affected firm, as well as for the whole industry group to which the firm belongs. As an illustration, we analyze a sample of ten fatal accidents experienced by major US domestic airlines during the last seven years. In four cases, we observed an abnormal market response. In these instances, it seems that the shareholders may have updated their estimates of the probability of a future accident in the affected airlines or more generally of the firm's future business prospects. This market reaction is not always easy to explain much less to anticipate, a fact which management should bear in mind when planning a firm's response to such an event.

Suggested Citation

  • Robin L. Dillon & Blake E. Johnson & M. Elisabeth Patè‐Cornell, 1999. "Risk Assessment Based on Financial Data: Market Response to Airline Accidents," Risk Analysis, John Wiley & Sons, vol. 19(3), pages 473-486, June.
    • Handle: RePEc:wly:riskan:v:19:y:1999:i:3:p:473-486
    DOI: 10.1111/j.1539-6924.1999.tb00422.x
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    References listed on IDEAS

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    Cited by:

    1. Severin Borenstein & Nancy L. Rose, 2014. "How Airline Markets Work…or Do They? Regulatory Reform in the Airline Industry," NBER Chapters, in: Economic Regulation and Its Reform: What Have We Learned?, pages 63-135, National Bureau of Economic Research, Inc.
    2. Akyildirim, Erdinc & Corbet, Shaen & Efthymiou, Marina & Guiomard, Cathal & O'Connell, John F. & Sensoy, Ahmet, 2020. "The financial market effects of international aviation disasters," International Review of Financial Analysis, Elsevier, vol. 69(C).
    3. Severin Borenstein & Nancy L. Rose, 2007. "How Airline Markets Work...Or Do They? Regulatory Reform in the Airline Industry," NBER Working Papers 13452, National Bureau of Economic Research, Inc.

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