Do markets react rationally? An event study on the effect of the 2010 volcano eruption on airline stock returns

Sammanfattning: In April 2010, a volcano eruption in Iceland caused a temporary flight ban on most of European airspace resulting in a negative financial impact on European airlines in particular. By conducting an event study, we investigate if market participants reacted rationally to the effects of this event. Our results suggest that the capital market did not consider the effects of the flight ban as severe to individual airline companies. We find inconclusive results when testing if market participants differentiated between securities based on company characteristics. For the portfolio of European airlines, however, the exposure to the event has a certain explanatory power for abnormal returns. In addition, we find that on an industry level, investors were fairly good at quantifying the airlines' one-time loss. We conclude that the lack of significant results constrains us from drawing clear inferences on market rationality. However, despite the low significance of abnormal returns, we find that investors acted rationally to some extent by correctly assessing the magnitude of the financial impact.