The Red Sea conflict and market reactions: Examining the role of military strength in financial markets

Yudaruddin, Rizky; Lesmana, Dadang; Ekşi, İbrahim Halil; Ginn, William; Tabash, Mosab I. Article The Red Sea conflict and market reactions: Examining the role of military strength in financial markets Peace Economics, Peace Science and Public Policy (PEPS) Provided in Cooperation with: De Gruyter Brill Suggested Citation: Yudaruddin, Rizky; Lesmana, Dadang; Ekşi, İbrahim Halil; Ginn, William; Tabash, Mosab I. (2025) : The Red Sea conflict and market reactions: Examining the role of military strength in financial markets, Peace Economics, Peace Science and Public Policy (PEPS), ISSN 1554-8597, De Gruyter, Berlin, Vol. 31, Iss. 2, pp. 193-227, https://doi.org/10.1515/peps-2024-0052 This Version is available at: https://hdl.handle.net/10419/333343 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ Rizky Yudaruddin, Dadang Lesmana, İbrahim Halil EKŞİ, William Ginn and Mosab I. Tabash* The Red Sea Conflict and Market Reactions: Examining the Role of Military Strength in Financial Markets https://doi.org/10.1515/peps-2024-0052 Received December 2, 2024; accepted March 30, 2025; published online April 16, 2025 Abstract: This study examines market reactions to the US-Houthi conflict on January 11, 2024, across various markets, regions, and industries within the financial sector, emphasizing the role of military strength in shaping global financial responses. An event study methodology is applied to a sample of 3,239 financial sector companies, observing market reactions over multiple event windows: a 15-day preevent phase and a 15-day post-event phase surrounding the conflict announcement. Cross-sectional analysis is conducted to assess how military strength impacts financial market reactions. The results indicate significant market vulnerability to the US-Houthi conflict, particularly during the period from the event day on January 11, 2024, to the post-event phase, with developed markets experiencing the greatest impact. While American markets showed mixed responses, European, Middle Eastern, and African markets faced notable negative effects due to disrupted trade routes; Asian markets also showed negative reactions, though to a lesser extent. The banking industry recorded the most adverse reaction within the financial sector, and military strength emerged as a critical factor influencing investor behavior in response to the conflict. These findings highlight the need for policymakers to enhance financial market stability by considering military strength and trade route security in risk mitigation strategies, particularly in times of geopolitical uncertainty, such as the period surrounding the US-Houthi conflict in early 2024. Keywords: US-Houthi conflict; market reaction; event study; financial sector; military strength *Corresponding author: Mosab I. Tabash, College of Business, Al Ain University, Al Ain, United Arab Emirates, E-mail: [email protected] Rizky Yudaruddin, Department of Management, Mulawarman University, Samarinda, Indonesia Dadang Lesmana, Research and Innovation Agency Region East Kutai, Sangatta, Indonesia İbrahim Halil EKŞİ,Faculty of Economics and Administrative Sciences, Gaziantep University, Gaziantep, Türkiye William Ginn, Labcorp, Sr. Economist, Artificial Intelligence, USA and Coburg University of Applied Sciences, Coburg, Germany Peace Econ. Peace Sci. Pub. Pol. 2025; 31(2): 193–227 Open Access. © 2025 the author(s), published by De Gruyter. This work is licensed under the Creative Commons Attribution 4.0 International License. JEL Classification: G39; G41; F51; D53; E44 1 Introduction The world has experienced heightened geopolitical risks in the last decade compared to previous eras, and the intensity of these risks has become a significant concern for investors, especially in recent events such as the US-China trade war, the Israel-Hamas conflict, and the Russia-Ukraine war. Among these events, the financial sector is frequently negatively impacted by geopolitical risks (Boubaker et al. 2023; Chen and Sun 2024; Hunjra et al. 2024; Lesmana and Yudaruddin 2024a; Pandey et al. 2024; Polat et al. 2023; Polat, Başar, and Ekşi 2024; Shi, Wang, and Ke 2021; Vu et al. 2023; Yudaruddin et al. 2024a,b). Geopolitical risks are closely linked to the financial sector due to their significant impact on market stability and investor behavior. Events such as wars, trade conflicts, and political upheavals create uncertainty, leading to market volatility and disrupting financial markets. For instance, geopolitical conflicts can affect commodity prices, including crucial resources like oil and natural gas, which in turn influence inflation and economic growth (Babar, Ahmad, and Yousaf 2023; Yousaf et al. 2023; Yudaruddin and Lesmana 2024b; Yasmeen and Shah 2024). Additionally, these events often result in shifts in government policies and regulatory frameworks, further destabilizing financial markets. Investor sentiment tends to react negatively to geopolitical tensions, causing fluctuations in stock prices, foreign exchange rates, and bond yields (Assaf, Gupta, and Kumar 2023; Ngo, Nguyen, and Hoang 2024; Hassan et al. 2022; Jawadi et al. 2024). Consequently, the financial sector, including banking, investment, and insurance industries, becomes particularly vulnerable to the adverse effects of geopolitical risks, as seen in various recent global conflicts. This relationship underscores the importance of effective risk management strategies for financial institutions to mitigate the impacts of geopolitical uncertainties. Recently, the US-Houthi conflict has intensified as the US and the UK have launched a series of strikes on Yemen, targeting the Iran-aligned Houthi rebels who have been attacking international shipping in the Red Sea. The Houthis, who support the Palestinian group Hamas, condemned these strikes as “barbaric”and issued a statement declaring that “all US and UK interests have become ‘legitimate targets’.” 1 This conflict is part of a broader regional power struggle, with the Houthis receiving backing from Iran, and it has significant implications for international maritime 1https://www.aljazeera.com/news/2024/1/12/world-reacts-to-us-uk-attacks-on-houthi-targets-inyemen [Last accessed on March 25, 2025]. 194 R. Yudaruddin et al. security and geopolitical stability. 2 The Houthis’threats underscore the potential for further escalation, impacting not only the region but also global trade routes and international relations. Considering the escalating conflict and the Houthis’threats against US and UK interests, it is crucial to understand the broader implications beyond immediate security concerns. One significant aspect that warrants examination is the impact of such geopolitical tensions on the financial sector. Therefore, there are three main motivations in this study. First, several studies have indicated that the financial sector, particularly banking, is highly vulnerable to conflicts such as wars. Military deployments at border areas often serve as “bad”news for investors in the banking sector (Boubaker et al. 2023; Martins and Cró 2023; Vu et al. 2023; Yudaruddin and Lesmana 2024a). However, most of these studies focus on the Russia-Ukraine conflict, which involves financial sanctions between Russia and the European Union. This raises the question of how the financial sector market reacts to conflicts that do not involve financial sanctions, creating a research gap that needs to be addressed. Second, previous research has primarily concentrated on the banking industry, failing to provide a comprehensive view of the entire financial sector. Additionally, factors such as military strength, which are pertinent to war, have not been thoroughly explored in previous studies. Third, the US-Houthi conflict is strategically significant due to its location along major trade routes between Asia, Africa, Europe, and America. Essallamy, Bari, and Kotb (2020) and Wu et al. (2022) highlighted the crucial role of the Red Sea route through the Suez Canal, analyzing its effectiveness and cost efficiency compared to the Cape of Good Hope route. Recently, however, tensions in the Red Sea have led companies in Asia to prefer the Cape of Good Hope route to avoid risks, resulting in a sharp decline in Suez Canal transit and an increase in Cape of Good Hope traffic. The Panama Canal has also experienced a decline, albeit less severe than the Suez Canal. 3 Yudaruddin et al. (2025) showed that the US-Houthi conflict had a negative impact on the market in the consumer cyclical sector. This study thus seeks to assess the potential negative impact of the US-Houthi conflict on the financial sector’s stock market. To address this gap, our study is the first to investigate market reactions to the US-Houthi conflict within the financial sector. We analyze market reactions from 15 days before to 15 days after the event, using January 11, 2024, as the event day. Our research findings address the gap in previous research by demonstrating that investors in the financial sector exhibit a “negative”sensitivity to war. This is evident 2https://edition.cnn.com/middleeast/live-news/israel-hamas-war-gaza-news-01-11-24/index.html [Last accessed on March 26, 2025]. 3https://www.imf.org/en/Blogs/Articles/2024/03/07/Red-Sea-Attacks-Disrupt-Global-Trade [Last accessed on March 25, 2025]. The Red Sea Conflict and Market Reactions 195 from the significant negative market reaction to the US-Houthi conflict and its aftermath. These results reinforce previous findings that the financial system is highly integrated and that macroeconomic shocks increase systemic risk. Furthermore, we find that the banking industry exhibits higher vulnerability compared to other industries. Our results confirm that the banking market reacts significantly negatively to global uncertainties, including geopolitical risks, even in the absence of financial sanctions. Our findings also provide insights for companies regarding the importance of military strength and company characteristics in managing geopolitical risks. We find that while military power is not a critical factor in the absence of war, it becomes vital during conflicts, influencing market reactions to geopolitical risks. This paper is organized into five sections. The relevant literature is briefly discussed in Section 2. The methodology is presented in Section 3. In Section 4, the data and main empirical findings are displayed. The last section concludes. 2 Literature Review In recent years, many academics and practitioners have analyzed the impact of geopolitical conflicts particularly war events have far-reaching effects across various sectors. Tajaddini and Gholipour (2023) found that stock markets declined more in countries with strong trade ties to Russia and Ukraine during the Russia-Ukraine war, though trade openness mitigated the impact. Similarly, Boubaker et al. (2022) and Boungou and Yati´e (2022) reported that the Ukraine-Russia war caused global stock declines, hitting globalized economies, neighboring countries, and UN critics hardest, while NATO markets showed resilience. Martins and Cró (2023) illustrated this by highlighting the disruptions in flight routes caused by conflicts, which led airlines to avoid airspace near war-torn regions. Consequently, these limitations on flight routes have resulted in deteriorating aviation performance for companies operating in such areas. Similarly, Yudaruddin et al. (2023) identified a disruption in the agricultural supply chain in conflict-ridden nations like Ukraine, a significant exporter of wheat. This disruption triggered price hikes in various agricultural commodities, posing challenges for investors concerned about handling geopolitical risks. Furthermore, the real estate sector was not immune to these effects (Yudaruddin and Lesmana 2024c). Corsetti et al. (2012) emphasized that increasing sovereign risk adds new pressure to a country’s economic stability amid geopolitical pressures. As a result, investors are concerned about the level of sovereign risk that affects their business operations. Country risk, which includes legal, economic, and institutional dimensions, increasingly deters investors from engaging 196 R. Yudaruddin et al. in business activities in that environment (Lestari et al. 2022). As a result, the level of country risk increases uncertainty, which has a major impact on financial markets in both developing and developed countries (Hoque and Zaidi 2020). Geopolitical risks are also closely linked to the financial sector due to their significant impact on market stability and investor behavior. Investor sentiment tends to react negatively to geopolitical tensions, causing fluctuations in stock prices, sovereign wealth funds, foreign exchange rates, and bond yields (Assaf, Gupta, and Kumar 2023; Ngo, Nguyen, and Hoang 2024; Balestra et al. 2024; Hassan et al. 2022; Jawadi et al. 2024). Consequently, the financial sector often experiences adverse effects as a result of these geopolitical risks (Shi, Wang, and Ke 2021; Chen and Sun 2024; Pandey et al. 2024; Lesmana and Yudaruddin 2024b; Boubaker et al. 2023; Vu et al. 2023; Vuong et al. 2024). Shapiro,Switzer,andMastroianni(1999) examined the response of a portfolio of defense contractors to warand peacerelated events, finding that the defense portfolio responds positively to war-related announcements and negatively to peace-related announcements. Moreover, research by Yudaruddin and Lesmana (2024a) and Boubaker et al. (2023) underscores the vulnerability of the global banking sector to geopolitical uncertainties. Past conflicts have led to the imposition of banking access sanctions on warring nations, amplifying risks within the banking. This vulnerability is also triggered by the highly integrated financial system throughout the world, the presence of external disturbances creates increased systemic risk. In addition, the existence of geopolitical risks also raises the level of bank risk which can reduce banking performance (Hunjra et al. 2022). Moreover, several studies have examined the repercussions of war on financial markets across different regions. Abbassi, Kumari, and Pandey (2023) and Kamal, Ahmed, and Hasan (2023) focused on developed countries, while Lesmana and Yudaruddin (2024b), Yousaf, Patel, and Yarovaya (2022), Oubani (2024), Sayed (2024), Basnet, Blomkvist, and Galariotis (2022), and Oyadeyi, Arogundade, and Biyase (2024) studied emerging and frontier markets, with specific attention to Asia (Lesmana and Yudaruddin 2024b), Europe, and America (Boubaker et al. 2022). Kumari, Kumar, and Pandey (2023) found the impact of war on financial markets on the EU stock markets. Aslam et al. (2021) found that terrorist attacks, especially on certain weekdays, increased stock market volatility and negatively impacted returns in Pakistan. These investigations collectively illuminate the multifaceted impact of war on global economic systems and underscore the need for comprehensive strategies to mitigate such disruptions. Meanwhile, Rigobon and Sack (2005) Gurdgiev, Henrichsen, and Mulhair (2022), and Tee Wong, and Hooy (2023) also found a negative effect of war on US financial markets. The Red Sea Conflict and Market Reactions 197 Recently, the US-Houthi conflict has become a focus of attention, especially for countries that use trade routes via the Suez Canal, which connects the Red Sea and the Mediterranean Sea to the European and American continents. 4 , 5 , 6 The conflict has impacted the gateway to the Suez Canal, disrupting trade routes and forcing vessels to switch to the Cape of Good Hope route. This shift affects the ships’condition and longevity. Specifically, using the Suez Canal is more time-effective, reducing sailing time to Europe by approximately 42 % and to the US by 30 % from the Middle East. In contrast, the Cape of Good Hope route results in higher damage rates, with 13 % for Europe and 5 % for America (Essallamy, Bari, and Kotb 2020). Similar research by Wu et al. (2022) analyzed the integration of trade between the Suez Canal and the Cape of Good Hope, focusing on time and fuel cost effectiveness. Their findings indicate that the Suez Canal plays a much more effective and efficient role compared to the Cape of Good Hope route. In addition, Yap and Yang (2024) found that geopolitical risks disrupted shipping networks connecting the Asia-Europe and Asia-Mediterranean trade routes. The disruption of the Suez Canal due to the US-Houthi conflict forced the service company to use an alternative Cape route with a longer route, so the company added additional ships to maintain the frequency of stops. The US-Houthi conflict has an impact on increasing costs and shipping times, which is a “bad”signal for investors. Yudaruddin et al. (2023) stated that the impact of war can lead to an increase in commodity prices, which raises production costs and subsequently affects a company’s performance, potentially leading to a reduction in dividends. Dividends play a crucial communication role for companies and investors during crises (Hasan 2021). Subsequently, Tayachi et al. (2023) states that dividend policy also looks at several aspects other than institutional ownership and company performance. A decrease in dividends sends a negative signal to investors during times of war (Yudaruddin and Lesmana 2024c). The reaction to this can also vary based on the company’s scale, as the impact of geopolitical risk is closely associated with medium and large-scale companies engaged in international trade (Kamal, Ahmed, and Hasan 2023). Additionally, Chesney, Karaman, and Reshetar (2011) and Corbet, Gurdgiev, and Meegan (2017) demonstrated that terrorist activities drive stock market volatility. The economic repercussions of the US-Houthi conflict extend beyond disrupted trade routes and increased shipping costs, affecting various sectors and influencing investor behavior. The conflict’s impact on maritime trade and commodity prices 4https://www.theguardian.com/world/2024/jan/03/what-is-the-red-sea-crisis-and-what-does-itmean-for-global-trade [Last accessed on March 25, 2025]. 5https://www.theguardian.com/business/2023/dec/19/red-sea-shipping-crisis-bp-oil-explainedwhat-is-happening-and-what-does-it-mean-for-global-trade [Last accessed on March 26, 2025]. 6https://iea.blob.core.windows.net/assets/0a3c8da7-43ad-4511-a0ff-932fd8d0825a/SuezCanal-Factsheet.pdf [Last accessed on March 26, 2025]. 198 R. Yudaruddin et al. sends negative signals to investors, highlighting the broader implications of geopolitical tensions on financial stability. Therefore, military strength plays a crucial role in shaping investor sentiment and market reactions across various financial sectors, including banking services, collective investments, insurance, investment banking and investment services, and investment holding companies. Gurdgiev, Henrichsen, and Mulhair (2022) analyzed the effects of US military participation in both direct and indirect foreign conflicts and found that defense budget announcements have a complex and dynamic positive impact that is statistically significant on defense company stock performance. However, military spending presents two contrasting aspects for investors depending on the prevailing situation. Tutuncu, Bayraktar, and Khan (2024) found that a bidirectional relationship between military expenditures and geopolitical risk, where both influence each other and contribute to an arms race and regional instabilit. Saba and Ngepah (2019) found that, in African countries, most arms expenditures do not have a causal link to economic growth, with only two countries showing a significant relationship. In contrast, Tsitouras and Tsounis (2024) indicated that arms spending exacerbates inequality in conflict-affected countries like Greece, leading to negative investor sentiment toward military expenditures in stable conditions. Corsetti et al. (2012) observed that substantial military power reinforces national sovereignty, thereby easing investor concerns and boosting economic stability amid geopolitical tensions. Lowering geopolitical risk can raise stock returns in both emerging and developed economies (Hoque and Zaidi 2020). Indeed, military strength heavily influences investor perceptions by fostering a sense of stability and security. A country with robust military capabilities is often perceived as better equipped to defend its interests, reassuring investors and helping to mitigate negative impacts on stock prices during conflicts. Additionally, strong military capabilities usually translate into greater geopolitical influence, deterring adversaries and reducing the likelihood of prolonged conflicts. This stabilizing effect can lead to more favorable cumulative abnormal returns (CARs), as investors anticipate quicker conflict resolutions and lower risks of escalation. Conversely, Rigobon and Sack (2005) noted that rising war risks in U.S. financial markets lead to declines in treasury yields and equity prices, widening spreads on low-rated companies, dollar depreciation, and increases in oil prices. Schneider and Vera (2006) also found that conflicts adversely impact core financial markets in the Western world, specifically affecting stock indices in Paris, London, and the United States. Geopolitical risks (GPR) play a crucial role in shaping military expenditure policies and their subsequent impact on stock market reactions. The link between GPR and military expenditure not only affects economic stability but also triggers negative stock market reactions due to increased uncertainty and pressure on investment. For instance, Tran and Vo (2024) found that local GPR exerts a greater The Red Sea Conflict and Market Reactions 199 influence on military spending behavior than global GPR, indicating that countries adjust their defense policies based on regional threats. Menla and Dimitraki (2014) highlighted that the impact of military expenditure on economic growth is statedependent, where increased defense spending can negatively affect growth during periods of slow expansion and high volatility. Furthermore, Khraiche, Boudreau, and Chowdhury (2023) show that GPR has a strong negative effect on stock market development, with a more pronounced impact in North America and Europe than in Asia, indicating that geopolitical uncertainty hinders investment and capital market growth. 3 Data and Methodology We collected the daily closing prices of the leading stock indices sample firms in each country from The Wall Street Journal (WSJ) and the investing.com website (www. investing.com) for the period 1 December 2022 through 29 February 2024. We also collect daily closing composite stock price indexes of the markets from their constituent companies. We include all firms that we can match with the stock market and financial reports. After screening sample firms, the sample in this study comprised 2,339 companies in the financial sector’s stock market. The distribution of sample companies by country is presented in Table A1. We utilized the event study approach by Fama et al. (1969). Recent studies on market reactions to the announcement of war also use the event study method (Lesmana and Yudaruddin 2024b; Yudaruddin et al. 2023; Yudaruddin and Lesmana., 2024c; Pandey et al. 2024; Boubaker et al. 2023). We also utilized multiple event windows, including 15 days prior to the invasion announcement as a pre-invasion event and 15 days after the invasion announcement as a post-invasion event. In addition, we also used the 250 trading days prior to the event window in formulating a benchmark for normal returns to improve accuracy and reduce bias in the results of this study. This research takes place at the time of the US-Houthi conflict on January 11, 2024 7 , 8 , 9 as an event day. We measured the market reaction using the normal, abnormal and cumulative abnormal rates of return. 7https://www.nytimes.com/2024/01/11/us/politics/us-houthi-missile-strikes.html [Last accessed on March 26, 2025]. 8https://edition.cnn.com/2024/01/11/politics/us-strikes-houthis-yemen/index.html [Last accessed on March 26, 2025]. 9https://www.aljazeera.com/news/2024/1/11/any-us-attack-on-yemens-houthis-will-not-go-without [Last accessed on March 26, 2025]. 200 R. Yudaruddin et al. Table :Cumulative abnormal returns for pre-event, the event day, and post-event windows by industry. Industry Number of company Pre-event days Event days Post-event days (−,)(−,)(−,)(−,)(,+)(,+)(,+)(,+) Banking Service , .*** .*** .*** −.** −.** −.*** −. −.** Collective Investments  .*** .*** .*** .*−.*−.*. −. Insurance  −. −. −. −. . −. −. −. Investment Banking & Investment Services , −. . . . −. −.*** −.*** −.* Investment Holding Companies  .*** .** . . −. −. −. −.* Notes: CAR stands for cumulative abnormal return. The ordinate represents the event window. ***, **, and * are significant at %, %, and  % confidence levels, respectively, based on a one-sample t-test against the null hypothesis that CAR equals zero. Source: Authors’calculation. The Red Sea Conflict and Market Reactions 207 performance of defense companies, which is statistically significant. In the same vein, Kumari, Kumar, and Pandey (2023) demonstrate that while developed markets and NATO nations exhibit positive returns, abnormal returns during the post-event window are negatively influenced by economic sanctions and the fear of reduced exports. 4.4 The Impact of the US-Houthi Conflict on Market Reactions by Region and Industry Table 4 presents the cumulative abnormal returns (CARs) across different event windows for various industries in the Americas, Europe, Middle East & Africa, and Asia & Pacific regions. The results indicate distinct market reactions before, during, and after the event. In the Americas, the banking sector experienced significant negative CARs on the event day, followed by a partial recovery post-event, while the insurance sector showed a strong positive response post-event. In Europe, the banking and collective investment sectors had significant positive pre-event CARs, but negative reactions post-event. In the Middle East & Africa, the investment banking sector showed strong pre-event gains but declined significantly in the postevent window. Finally, in Asia & Pacific, investment banking and insurance sectors experienced negative CARs post-event, suggesting a weaker market response compared to other regions. The findings of this study indicate that market reactions to the US-Houthi conflict vary by region and industry sector, reflecting previous empirical evidence on the impact of geopolitical risk on financial stability and global investment. In the Americas, the results align with the studies of Hassan et al. (2022) and Jawadi et al. (2024), which found that the banking sector tends to experience significant pressure on the event day due to heightened uncertainty but partially recovers as investors have time to process information. Meanwhile, the positive post-event response in the insurance sector suggests that investors may anticipate increased demand for insurance products due to rising geopolitical risks, as highlighted in Chen and Sun (2024), which emphasizes how geopolitical crises can drive growth in the financial sector. In Europe, the positive pre-event reaction in the banking and collective investment sectors, followed by negative post-event performance, indicates initial market speculation that later undergoes correction as the conflict’s impact becomes clearer. This finding supports the study by Vuong et al. (2024), which shows that early expectations of geopolitical tensions often lead to spikes in abnormal returns, followed by adjustments as real risks materialize. Similarly, in the Middle East & Africa, the strong pre-event gains in the investment banking sector, followed by a significant 208 R. Yudaruddin et al. Table :Cumulative abnormal returns for pre-event, the event day, and post-event windows by region and industry. Industry Number of company Pre-event days Event days Post-event days (−,)(−,)(−,)(−,)(,+)(,+)(,+)(,+) Americas Banking Service  −. .*** . −.*** −.*** . .*** −.** Collective Investments  . . .*−. −.** −. . −. Insurance  . . . . −. .*** .*** . Investment Banking & Investment Services  . . .*−.*−. .*.** . Investment Holding Companies  . . . −. −. −. . . Europe Banking Service  .*** .*** .*. −. −.*** −. −.*** Collective Investments  .*** .*** .** .*** −. −.*** . −. Insurance  .*.*** . . . . .*** . Investment Banking & Investment Services  .** .** . . . −. −. −.** Investment Holding Companies  . . −. . . −. . −. Middle East & Africa Banking Service  .*** .*** .*** −. .** −. −.** −.** Collective Investments . −. . . . −. −. −. Insurance  −. −. .*** −. . . −.** −.** Investment Banking & Investment Services  .*** .*** .*** .** . −. −. −.** Investment Holding Companies  .*. . . . . −. −. Asia & Pacific Banking Service  . .*** .** −.*** −. −.*−. −. Collective Investments  . . . −. . . . −. Insurance  −. −. −. −. −. −. −. −. Investment Banking & Investment Services  −. −. −. . −. −.*** −.*** −.*** Investment Holding Companies  .** .** . −. −. −. −. −. Notes: CAR stands for cumulative abnormal return. The ordinate represents the event window. ***, **, and * are significant at %, %, and  % confidence levels, respectively, based on a one-sample t-test against the null hypothesis that CAR equals zero. Source: Authors’calculation. The Red Sea Conflict and Market Reactions 209 decline post-event, reflect trends similar to those found in Boubaker et al. (2023), which observed that banks in politically unstable regions are more vulnerable to volatility due to rapidly shifting investor expectations. In Asia & the Pacific, the weak post-event response in the investment banking and insurance sectors suggests that the impact of the US-Houthi conflict was not as pronounced as in other regions. This is consistent with the findings of Oubani (2024) and Lesmana and Yudaruddin (2024b), which suggest that Asia’s more diversified economic structure may help mitigate the direct effects of geopolitical shocks. 4.5 Cross Sectional Analysis Additionaly, we conduct a cross-sectional analysis the impact of military strength on market reactions in the financial sector. We also analysis the impact of firm charateristic on market reaction. Table 5 presents the descriptive statistics and the correlation matrix in Table 6 to overcome the multicollinearity problem. In Table 7, our analysis reveals that prior to the onset of the war, military strength did not significantly influence investor concerns. However, once the conflict began, military strength emerged as a crucial factor shaping market reactions. The data presented in Table 7 indicate a significant negative relationship between military strength, as proxied by the Nation Power Index (NPI), and market reactions within the financial sector on both the event day and the post-event day. This suggests that, while military strength was previously a minor consideration, it became a prominent factor influencing investor behavior during the conflict. Table :Summary statistics of variables (N=,). Variables Mean p Median p Std. dev. CAR (−,). −. . . . CAR (−,). −. . . . CAR (−,). −. . . . CAR (−,)−. −. −. . . CAR (,+)−. −. −. . . CAR (,+)−. −. −. . . CAR (,+)−. −. . . . CAR (,+)−. −. −. . . NPI . . . . . ROA −. . . . . SIZE . . . . . LEV . . . . . LIQ . . . . . CAR, cumulative abnormal returns; NPI, the Nation’s Power Index or PwrIndx; ROA, net income before taxes to total asset; DIV, dummy variable, for firms that pay dividends and for no pay. A total of , companies (.%) pay dividends, while  companies (.%) do not. SIZE, logarithm of total asset; LEV, total liabilities total equity; LIQ, total current assets to total asset. Source: Authors’calculation. 210 R. Yudaruddin et al. The findings demonstrate that stronger military capabilities are associated with more positive investor reactions. This relationship underscores the role of military strength in shaping investor perceptions of stability and security. Countries with robust military forces are perceived as better equipped to safeguard their interests, which can instill confidence among investors and mitigate the adverse effects on stock prices during periods of conflict. Consequently, the presence of a strong military can reassure investors by reducing perceived risks associated with geopolitical instability. These results align with the work of Corsetti et al. (2012), who highlighted the importance of military power in maintaining economic stability. Their research suggests that a country’s military strength plays a significant role in fostering a favorable business environment, thereby enhancing investor confidence and comfort in operating within the country. Similarly, Gurdgiev, Henrichsen, and Mulhair (2022) discovered that announcements regarding defense budgets have a statistically significant influence on the performance of defense company stocks when US military participation in both direct and indirect foreign conflicts. Thus, our findings reinforce the notion that military power is a key determinant of economic stability and investor sentiment during conflicts. Regarding control variables, our analysis reveals that Return on Assets (ROA) has a significant negative effect on market reactions before the announcement of the US-Houthi conflict. This finding suggests that despite high levels of profitability, companies are unable to mitigate the concerns associated with geopolitical risk, indicating persistent investor apprehension. This result is consistent with Pessarossi, Thvenon, and Weill (2020), who found that banks with high profitability do not necessarily experience reduced financial distress during crises. Moreover, Basnet, Blomkvist, and Galariotis (2022) argue that high profitability might even exacerbate Table :Pearson’s correlation and variance inflation factor. Variables MSI ROA DIV SIZE LEV LIQ Variance inflation factor (VIF) NPI . . ROA . . . DIV . . . . SIZE −. . .*** . . LEV . . .*** .*** . . LIQ −. . −. −.*** −. . . NPI, the Nation’s Power Index or PwrIndx; ROA, net income before taxes to total asset; DIV, dummy variable; for firms that pay dividends and for no pay; SIZE, logarithm of total asset; LEV,total liabilities total equity; LIQ, total current assets to total asset. ***, **, and * are significant at %, %, and  %confidence levels, respectively. Source: Authors’ calculation. The Red Sea Conflict and Market Reactions 211 Table :Cross-sectional regression analysis of cumulative abnormal returns. Variables Pre-event days Event days Post-event days (−,)(−,)(−,)(−,)(,+)(,+)(,+)(,+) NPI −. −. −. −.** −.*** −.** −.** −.* (−.)(−.)(−.)(−.)(−.)(−.)(−.)(−.) ROA −. . −.** . −. −. −. −. (−.)(.)(−.)(.)(−.)(−.)(−.)(−.) LIQ .*** .*** .*** .*** . −. . . (.)(.)(.)(.)(.)(−.)(.)(.) LEV .** . .*−. −. −. −. −. (.)(.)(.)(−.)(−.)(−.)(−.)(−.) DIV −. −. −. . .** .** . . (−.)(−.)(−.)(.)(.)(.)(.)(.) SIZE −.*** −.** −.*−. −. . .*.* (−.)(−.)(−.)(−.)(−.)(.)(.)(.) Constant .*. .*.** .*** .** .** . (.)(.)(.)(.)(.)(.)(.)(.) Country dummy Yes Yes Yes Yes Yes Yes Yes Yes Industry dummy Yes Yes Yes Yes Yes Yes Yes Yes Rsquare . . . . . . . . Obs. , , , , , , , , NPI, the Nation’s Power Index or PwrIndx; ROA, net income before taxes to total asset; DIV, dummy variable; for firms that pay dividends and for no pay; SIZE, logarithm of total asset; LEV, total liabilities total equity; LIQ, total current assets to total asset. ***, **, and * are significant at %, %, and  % confidence levels, respectively. Source: Authors’calculation. 212 R. Yudaruddin et al. negative sentiment related to “human rights”issues in conflict situations, thereby failing to alleviate geopolitical risks. Conversely, our results show that leverage has a significant positive effect on market reactions before the announcement. This suggests that a high leverage ratio, combined with expanded banking operations, contributes to perceived banking stability. This is supported by Acosta-Smith, Grill, and Lang (2020) and Kiema and Jokivuelle (2014), who noted that banks with a non-riskweighted leverage ratio requirement (LRR) tend to adopt low-risk lending strategies due to their diversified loan portfolios. Additionally, liquidity demonstrates a significant positive effect on market reactions. Banks with substantial liquid assets are more likely to elicit positive market responses. This aligns with Musneh, Karim, and Arokiadasan Baburaw (2021), who found that companies with high liquidity benefit during market downturns, as they can effectively design investment strategies and manage liquid assets. Regarding dividends, we observe a negative but non-significant impact before the announcement, with a significant positive effect afterward. This indicates that while dividend distribution initially has minimal effect, it becomes an effective tool for reducing geopolitical risk following the announcement. Hasan (2021) supports this by highlighting the crucial role of dividends in mitigating risk during crises. Finally, the variable SIZE exhibits different impacts before and after the announcement. Prior to the announcement, SIZE has a significant negative effect on market reactions, suggesting that smaller companies are more vulnerable to external shocks such as conflicts (Vu et al. 2023). In contrast, after the announcement, SIZE shows a significant positive effect. This shift indicates that larger companies, with their extensive international integration, are better positioned to handle disturbances like geopolitical risks and global uncertainties, which aligns with Kamal, Ahmed, and Hasan (2023) on the increased risk to international financial stability for companies engaged in global transactions. In the next stage, we also analysis the impact of military strength on market reactions by market (Table 8) and region (Table 9). Our analysis reveals that the Nation Power Index has a significant positive effect on market reactions in developed markets before and during the announcement of the conflict. This suggests that investors in developed countries perceive an increase in military power as a negative signal, associating it with a higher risk of potential conflict. This reaction can be attributed to heightened geopolitical tensions, which amplify fears of an escalating conflict or prolonged instability. A robust military signal can suggest an increased likelihood of further hostilities, leading to greater uncertainty and risk in the financial markets. The potential for extended conflicts often results in economic sanctions and trade disruptions, which can adversely impact businesses and financial institutions, further exacerbating investor concerns. In contrast, in frontier markets, the NPI demonstrates a significant negative effect on market reactions prior The Red Sea Conflict and Market Reactions 213 Table :Cross-sectional regression analysis of cumulative abnormal returns by market. Variables Pre-event days Event days Post-event days (−,)(−,)(−,)(−,)(,+)(,+)(,+)(,+) Panel A: Developed markets NPI . .*.*.** .*−. −. . (.)(.)(.)(.)(.)(−.)(−.)(.) Constant . . . −.** −.*** −. −. −.*** (.)(.)(.)(−.)(−.)(−.)(−.)(−.) Country dummy Yes Yes Yes Yes Yes Yes Yes Yes Industry dummy Yes Yes Yes Yes Yes Yes Yes Yes Rsquare . . . . . . . . Obs.         Panel B: Emerging markets NPI . −. −. −. −. −.*** −. −. (.)(−.)(−.)(−.)(−.)(−.)(−.)(−.) Constant . .*** .*.*. .*. . (.)(.)(.)(.)(.)(.)(.)(.) Country dummy Yes Yes Yes Yes Yes Yes Yes Yes Industry dummy Yes Yes Yes Yes Yes Yes Yes Yes Rsquare . . . . . . . . Obs.         Panel C: Frontier markets NPI −.** −. −.** −.*** −. −. −. . (−.)(−.)( −.)(−.)(−.)(−.)(−.)(.) Constant .** .*.*. . .*** .** .* (.)(.)(.)(.)(.)(.)(.)(.) Country dummy Yes Yes Yes Yes Yes Yes Yes Yes 214 R. Yudaruddin et al. Table :(continued) Variables Pre-event days Event days Post-event days (−,)(−,)(−,)(−,)(,+)(,+)(,+)(,+) Industry dummy Yes Yes Yes Yes Yes Yes Yes Yes Rsquare . . . . . . . . Obs.         NPI, the Nation’s Power Index or PwrIndx. ***, **, and * are significant at %, %, and  %confidence levels, respectively. Source: Authors’calculation. The Red Sea Conflict and Market Reactions 215 Table :Cross-sectional regression analysis of cumulative abnormal returns by region. Variables Pre-event days Event days Post-event days (−,)(−,)(−,)(−,)(,+)(,+)(,+)(,+) Panel A: Americas NPI −.*−. −. −.** −.*** −. −.*** −. (−.)(−.)(−.)(−.)(−.)(−.)(−.)(−.) Constant . . . .** .*** . .*** . (.)(.)(.)(.)(.)(.)(.)(.) Country dummy Yes Yes Yes Yes Yes Yes Yes Yes Industry dummy Yes Yes Yes Yes Yes Yes Yes Yes Rsquare . . . . . . . . Obs.         Panel B: Europe NPI −. . −.** −.*. . −. −. (−.)(.)(−.)(−.)(.)(.)(−.)(−.) Constant .*** .*** . . −. −.*** −.** −.** (.)(.)(.)(.)(−.)(−.)(−.)(−.) Country dummy Yes Yes Yes Yes Yes Yes Yes Yes Industry dummy Yes Yes Yes Yes Yes Yes Yes Yes Rsquare . . . . . . . . Obs. , , , , , , , , Panel C: Middle East & Africa NPI −. . −.*−.*** . . . . (−.)(.)(−.)(−.)(.)(.)(.)(.) Constant . . .** .*** −. −. −. −. (.)(.)(.)(.)(−.)(−.)(−.)( −.) Country dummy Yes Yes Yes Yes Yes Yes Yes Yes Industry dummy Yes Yes Yes Yes Yes Yes Yes Yes 216 R. Yudaruddin et al. Table A:Cross-sectional regression analysis of cumulative abnormal returns with Winsorization (at level %). Variables Pre-event days Event days Post-event days (−,)(−,)(−,)(−,)(,+)(,+)(,+)(,+) NPI −. −. −. −.** −.*** −.*** −.*** −.** (−.)(−.)(−.)(−.)(−.)(−.)(−.)(−.) ROA . −. −.** −. . . .** .*** (.)(−.)(−.)(−.)(.)(.)(.)(.) LIQ . . . . −. −. . . (.)(.)(.)(.)(−.)(−.)(.)(.) LEV . −. . −. −.** −. −.*−.* (.)(−.)(.)(−.)(−.)(−.)(−.)(−.) DIV −.** −.*−.** . .** .*** .** .* (−.)(−.)(−.)(.)(.)(.)(.)(.) SIZE −.*** −.*−. −. −. . .*** .*** (−.)(−.)(−.)(−.)(−.)(.)(.)(.) Constant .*. . .** .*** .** .** . (.)(.)(.)(.)( .)(.)(.)(.) Country dummy Yes Yes Yes Yes Yes Yes Yes Yes Industry dummy Yes Yes Yes Yes Yes Yes Yes Yes Rsquare . . . . . . . . Obs. , , , , , , , , Notes: NPI, the Nation’s Power Index or PwrIndx; ROA, net income before taxes to total asset; DIV, dummy variable; for firms that pay dividends and for no pay; SIZE, logarithm of total asset; LEV, total liabilities total equity; LIQ, total current assets to total asset. ***, **, and * are significant at %, %, and  % confidence levels, respectively. 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