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War-related risks and the İstanbul bourse on the eve of the First World War
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Borsa _Istanbul Review _ Borsa Istanbul Review xx (2015) 1e8
http://www.elsevier.com/journals/borsa-istanbul-review/2214-8450
_ War-related risks and the Istanbul bourse on the eve of the First World War* € Avni Onder Hanedar a,*, Erdost Torun a,b, Elmas Yaldız Hanedar c _ Dokuz Eylu¨l University, Faculty of Business, Izmir, Turkey Academia Sinica, Institute of Economics, Taipei, Taiwan c _ Yeditepe University, Faculty of Economics and Administrative Sciences, Istanbul, Turkey a
b
Received 18 September 2014; revised 23 May 2015; accepted 23 May 2015 Available online ▪ ▪ ▪
Abstract The lack of well-documented information in the historical literature on the relationship between war-related expectations and their effects on the bond market in the Ottoman Empire motivates this paper's three contributions. First, this paper is the first empirical study to investigate the break points in the volatility of Ottoman bond prices from a historical point of view. Second, we use the econometric technique developed by Inclan and Tiao (1994) to identify the structural breaks. Last, we use a manually collected dataset from the daily newspapers of the time on daily Ottoman bond prices from 1910 to 1914. Subsequently, we identify five structural break dates, each of them corresponding to important warrelated events. When we investigate the commentaries in the Ottoman newspapers, we see that the outbreak of several wars might not have been a surprise for investors in the Ottoman Empire, as reflected by government bond prices. _ Copyright © 2015, Borsa Istanbul Anonim S¸irketi. Production and hosting by Elsevier B.V. This is an open access article under the CC BY-NCND license (http://creativecommons.org/licenses/by-nc-nd/4.0/). JEL classification: G1; N25; N45 Keywords: The Turco-Italian war; Ottoman government bonds; Inclan-Tiao test
1. Introduction Recent studies on today's Turkey show that financial markets have often been affected by the political events (Basdas & Oran, € _ ¨ lku¨, 2012). 2014; Onder & S¸imga-Mugan, 2006; Ikizlerli &U Specifically, government bond prices are related to fiscal deficits. As the fiscal deficit rises, the value of a government bond drops and its yield rises due to high default risk; leading to an increased cost of borrowing for the government. The outbreak of a war would be interpreted as negative news since it implies budget deficits, higher interest rates, and higher default risk of governments (Ferguson, 2006). Accordingly, war-related * We would like to thank the two anonymous referees for their suggestions. We are also grateful for feedback, support, and helpful comments by Necla Geyikda gı, S¸evket Pamuk, Ragıp Yılmaz, participants of AGDES¸ seminar and students at the Turkish Military Academy. * Corresponding author. Dokuz Eylu¨l University, Faculty of Business, _ Kaynaklar Yerles‚kesi, 35160 Buca, Izmir, Turkey. Tel.: þ90 5393453073. € Hanedar). E-mail address: [email protected] (A.O. _ Peer review under responsibility of Borsa Istanbul Anonim Sirketi.
expectations change the behaviour of investors to avoid losses or make profits, which leads to structural breaks in the volatility of bond prices. Several papers have examined the effects of wars on bond markets in the US, Europe and China (Brown & Burdekin, 2000; Brown & Burdekin, 2002; Frey & Kucher, 2000, 2001; Ho & Li, 2014; Oosterlinck, 2003; Rigobon & Sack, 2005; Waldenstr€om & Frey, 2008; Willard, Guinnane, & Rosen, 1996). These studies have focused on the recent IraqUS war, the American Civil War and most of all on the Second World War. In addition, two papers have investigated the effects of WWI on European asset prices. Elmendorf, Hirschfeld, and Weil (1996) found that war news during WWI affected the variances of returns on British government bonds. Ferguson (2006) did not identify an important increase in war risk during the political crises of 1880e1914, which would have led to substantial change in yields for bonds of Great Powers1 traded on the London bourse. However, there is 1
The UK, Italy, Germany, Austria-Hungary, and Russia.
http://dx.doi.org/10.1016/j.bir.2015.05.001 _ 2214-8450/Copyright © 2015, Borsa Istanbul Anonim S¸irketi. Production and hosting by Elsevier B.V. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/). € et al., War-related risks and the Istanbul _ _ Please cite this article in press as: Hanedar, A. O., bourse on the eve of the First World War, Borsa Istanbul Review (2015), http://dx.doi.org/10.1016/j.bir.2015.05.001
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no well-documented information on the relationship between war-related risks and the bond market in the Ottoman Empire. Between 1910 and 1914, the Ottoman Empire was involved in four wars: the Turco-Italian, the First Balkan, the Second Balkan, and the First World War (WWI), all of which led to high war expenditures and an increased debt burden of the Ottoman Empire.2 The Turco-Italian war started on 29 September 1911, as Italy presented an ultimatum to occupy Libya. During September 1911, Ottoman newspapers often featured news related to the desire of Italian nationalists and newspapers to seize Libya. As the Ottoman state believed that Germany would have prevented such an attack (Beehler, 1913: p. 16; Herrmann, 1989: pp. 337e8), the Turco-Italian war caught the Ottoman government unprepared (Childs, 2008: p. 72; Giolitti, 2012: p. 59). Similarly, Hall (2000: p. 14) maintains that the Ottoman state considered the outbreak of a war with the Balkan states to be a low risk. In fact, although Bulgaria was improving its military capacity prior to the First Balkan war, the Ottoman state did not recruit soldiers in response (Tanin, 27 September 1912: p. 1). The Second Balkan war officially broke out on 29 June 1913 with Bulgaria's surprise attack on Serbia (Erickson, 2001: p. 3). With the assassination of Archduke Franz Ferdinand by a Serbian nationalist on 28 June 1914, ongoing tensions related to the former wars increased, leading to the outbreak of WWI (Henig, 2002: pp. 15e6; Erickson, 2001: p. 25; Ferguson, 2006). The aim of this paper is to shed light on the existence of war-related expectations prior to wars in the Ottoman Empire from 1910 to 1914. To this end, we estimate structural break points in variances of government bonds due to the war threats and risks perceived by bondholders in the Ottoman Empire with a specific focus on the fluctuations in prices of government bonds traded on the _ Istanbul bourse between 1910 and 1914. We use the econometric method developed by Inclan and Tiao (1994) to identify the structural breaks in the volatility of bond prices. This method allows endogeneous selection of break points without using any prior information. The vast majority of finance studies use Inclan and Tiao's (1994) test instead of Bai and Perron's (1998, 2003) method, as financial instability and hence risk could be identified with breaks in volatility rather than sudden changes in price series. A review of literature seems to indicate that, our paper is the first study to use this methodology in a historical context. We use daily observations of Treasury and Rumelia Railway _ bond prices traded on the Istanbul bourse from 1910 to 1914. We collected these data manually from Ottoman newspapers, which have never been used before to empirically examine the 2
The Ottoman Empire joined WWI in November 1914, but we were only able to extend our sample until July 1914 as there were no available data up to November 1914. 3 Several studies have used data for the Ottoman government bonds traded in Europe, such as Mauro, Sussman, and Yafeh (2006) and Tunçer (2009). In contrast to these researches, using manually collected daily prices from the Ottoman newspapers, our paper is the first to examine whether threats and _ risks due to the wars between 1910 and 1914 were forecasted at the Istanbul bourse.
_ war-related information flow into the Istanbul bourse.3 The _ data also allowed us to examine how the Istanbul bourse perceived war-related risks. In addition to the methodology used in the paper, the novelty of this dataset can be regarded as one of the most important contributions of our paper. The case we examine is informative for understanding the _ reaction of the Istanbul bourse to the war threats. Our findings show that bond price variances included break points that coincided with the Turco-Italian and the First Balkan wars. In addition, prior to the outbreak of these wars, there was a significant _ war expectation among the investors at the Istanbul bourse, which led to lower bond prices. This is in line with the arguments _ _ of a commentary in Ikdam, a widely read newspaper in Istanbul, on the negative relationship between war-related news dissemination and the demand of the bondholders for Ottoman gov_ ernment bonds (Ikdam, 25 September 1911: p. 1). The financial situation of the Ottoman Empire worsened before the wars (Geyikdagı, 2011: pp. 119e26), as budget deficits increased due to war expenditures (Beehler, 1913: p. 82). The results therefore imply that the Ottoman state did not anticipate these wars that did not come as a surprise, in contrast to the investors trading at the _ Istanbul bourse who would have lost money. The remainder of this paper is organized as follows. The _ next section presents the historical background of the Istanbul bourse, government bonds, and news dissemination in the Ottoman Empire. Section 3 and 4 provide information on the data and model. Section 5 presents the empirical results, before the conclusions. _ 2. The Istanbul bourse, government bonds, and news After the Crimean War (1853e1856), the financial situation of the Ottoman Empire worsened. The Ottoman state borrowed from abroad, and a treasury bond, the Konsolid bond, was issued. The bond was traded over the counter in Galata, _ Istanbul, and also on the Paris and London bourses. Furthermore, investors in the Ottoman Empire invested in shares of European joint-stock firms before the foundation of a formal market (Borsa Rehberi-1928, 1990a: pp. 15e6; Kazgan et al., 1999: pp. 371e75; Fertekligil, 2000: pp. 15, 23). Over time, many joint-stock companies were founded, and new government bonds were issued by the Ottoman state. To regulate the growing market, a bourse to exchange bonds, stocks, and foreign currencies was officially established by the Ottoman _ state in 1866, known as the “Istanbul Bond Market” (Dersaadet Tahvilat Borsası). The bourse regulations were copied from the European bourses (Kazgan, 1995: p. 67; Kazgan et al., 1999: p. 375; Fertekligil, 2000: p. 26; Toprak, 2008: p. 151). In the 1870s, eight financial assets were traded on the bourse, including treasury bonds of the Ottoman state and foreign bonds, e.g., the Bosporus Navigation Company's bond (S¸irket-i Hayriye). After 1908, Ottoman citizens were permitted to found joint-stock firms. The number of joint-stock and limited companies established in the Ottoman Empire increased from four in 1908 to twenty-four in 1910. Consequently, new domestic bonds and stocks were issued. As of 1914, one hundred and four bonds and stocks were issued by
€ et al., War-related risks and the Istanbul _ _ Please cite this article in press as: Hanedar, A. O., bourse on the eve of the First World War, Borsa Istanbul Review (2015), http://dx.doi.org/10.1016/j.bir.2015.05.001
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the Ottoman state as well as by foreign and domestic companies (Kazgan et al., 1999: p. 344; Fertekligil, 2000: pp. 44e5). Studies on the bond markets of different countries show that wars signify negative news about the future of governments, leading to lower government bond prices (e.g., Frey & Kucher, 2000, 2001; Ferguson, 2006; Ho & Li, 2014; Waldenstr€om & _ Frey, 2008). Similarly, a commentary in Ikdamdan Ottoman newspaperdargued that on 23 September 1911 the prices of government bonds were negatively affected by news about Italy's desire to invade Libya. The prices recovered on 24 September after investors believed that this news was _ misleading (Ikdam, 25 September 1911: p. 1). This commentary shows how quickly war-related news disseminated to investors in the Ottoman Empire, which affected bond prices. 3. Data We use the closing price data of the Treasury and the Rumelia Railway bonds because there is not much information on the prices of the other government bonds. It should be noted that the historical literature does not provide clear information about the turnover and investor _ profile on the Istanbul bourse. According to several sources, such as Borsa Rehberi-1928 (1990b: p. 337), Kazgan (1995: p. 95) and Fertekligil (2000: p. 82), the Treasury and the Rumelia Railway bonds were the biggest and the most frequently traded _ government bonds on the Istanbul bourse. The total debts collected with those bonds were 42,275,772 and 79,200,000 Turkish Liras, respectively. These were the highest figures in Ottoman foreign debt. With dreams of becoming rich, even ordinary people living in different parts of the Ottoman Empire traded at the bourse and bought a large amount of these government bonds. Government officers and members of the Ottoman dynasty constituted an important fraction of the bondholders. Non-Muslim citizens of the Ottoman Empire, bankers, and foreign banks were also important bondholders due to their links with European finance capitals. In addition, foreign investors, and even Allied soldiers during the occupation years had already invested in these bonds (Kazgan, 1995: pp. 95, 106; Kazgan et al., 1999: pp. 375, 406; Fertekligil, 2000: pp. 82, 89e90, 102e3). Moreover, the Rumelia Railway bond was called the Turkish Lottery bond, as it included € ¨ ksel, 2014: p. 16). lottery prizes to attract small investors (Ozyu The bond price data come from available volumes of Tercu¨man-ı Hakikat and Tanin. The major source is Tercu¨man-ı Hakikat, which had many available issues. By the end of the nineteenth century, Tercu¨man-ı Hakikat was a widely circu_ lated daily Ottoman newspaper in Istanbul, according to Karpat (2002: pp. 269e70). We used Tanin as an alternative source when several issues of Tercu¨man-ı Hakikat could not be found. In addition, bond prices were not reported in some issues. Tercu¨man-ı Hakikat, the first issue of which was published in 1878, was an opposition newspaper. Tanin was established as a pro-government newspaper; however, after 1911 it criticized the Ottoman government harshly and was closed down. Those newspapers had a column on the opening and closing prices of several bonds. The National Library of
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Turkey and the Beyazıt State Library provide digital copies of these newspapers. From these sources, we manually extracted data that have not been used before. In the newspapers, bond prices were only reported for the period between 2 November 1910 and 31 July 1914.4 The Treasury bond was a consolidated bond that replaced the earlier bonds except the Rumelia Railway bond. 1,488,126 consolidated bonds, which had a face value of 22 Ottoman Liras, were issued on 1 September and 14 September 1908. The rate of interest on the Treasury bond was 4 percent (Yeniay, 1964: pp. 90e1; Borsa Rehberi-1928, 1990a: p. 153, 1990b: p. 100). There is no detailed information on the maturity date of the bond, as similar bonds issued in these years were to be repaid between 50 and 100 years (Yeniay, 1964). In the data sources, the bond price is denominated in Kurus‚es. The bond could also be bought in British Pounds or French Francs (Yeniay, 1964: p. 91). The Rumelia Railway bond was issued by the Ottoman state to fund railroad building in the European part of the Ottoman Empire. The Ottoman state would have paid money in French Francs to the railroad building company of Baron de Hirsch. This probably explains why the face value of this bond was 400 French Francs. 1,980,000 bonds with a 104-year maturity were offered to the public on 10 March 1870 and 12 September 1872. The yield of these Rumelia Railway bonds was 3 percent (Yeniay, 1964: pp. 43e4; Borsa Rehberi-1928, 1990b: pp. 83e6; Akyıldız, 2001: p. 106). The Rumelia Railway bond is denominated in French Francs in the data sources. Because the exchange rates were constant over the sample period, we do not need to convert the price of the Rumelia Railway bond into Kurus‚es. 4. Methodology We identify the break points in the volatility of the Ottoman government bond prices by using an Iterative Cumulative Sums of Squares (ICSS) algorithm as proposed by Inclan and Tiao (1994). Recently, Waldenstr€om and Frey (2008) used Bai and Perron's (1998, 2003) method to examine the effects of warrelated risks in Nordic countries during the Second World War, identifying breaks in bond yields. Inclan and Tiao (1994) suggest that the sudden change in variance or volatility is a better measure of risk perceived by bondholders rather than breaks in bond prices. So, ICSS is superior to Bai and Perron's (1998, 2003) method. ICSS is a nonparametric method5 and endogenously determines the break points by using squared price changes, 4 It should be noted that our results may alter if the sample period had started from another year. Different break points could have been detected because of periodization. For instance, if the sample period started in 1907, then we could have identified break points in 1908 as there were several important political events, e.g., the annexation of Bosnia-Herzegovina by AustriaeHungary, which could have led to higher volatility in Ottoman bond prices due to the possibility of the outbreak of a war. 5 We also identify break dates by using Bai and Perron's (1998, 2003) method. As this is a parametric method, the findings vary due to the different data distribution assumption and estimation methods, in contrast to those of the ICSS test. That is the one of the reasons why we prefer using the ICSS.
€ et al., War-related risks and the Istanbul _ _ Please cite this article in press as: Hanedar, A. O., bourse on the eve of the First World War, Borsa Istanbul Review (2015), http://dx.doi.org/10.1016/j.bir.2015.05.001
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which does not require any prior information on the distribution of series and the timing and existence of breaks. Moreover, ICSS does not require an exogenous selection for the maximum number of break points, in contrast to Bai and Perron's (1998, 2003) method. ICSS assumes that a time series of interest has a variance interrupted by an unknown number of sudden changes. To estimate both the number and the time point of changes in variance, ICSS uses the centred (and normalized) cumulative sum of squares statistic defined as: Dk ¼ ðCk = þ CT Þ ðk=TÞ k ¼ 1;…;T with D0 ¼ Dk ¼ 0 ð1Þ P where T is the number of observations. Ck ¼ kt¼1 ε2t denotes the cumulative sum of squared observations from start of the series until the kth point in time. The plot of the Dk statistic against k oscillates around zero for the observations having homogenous variance with no sudden changes. As a sudden change takes place in variance, the plot of Dk exhibits a pattern going out of some specified boundaries with high probability. ICSS is based on detecting maximum deviation from these boundaries. If the maximum value of jDk j is greater than the critical value, the null hypothesis of no change can be rejected. Prices of government bonds may not be stationary, which may lead to biased test statistics. To this end, we use returns of government bonds, which are estimated by the following formula: Rt ¼ lnðPt =Pt1 Þ
ð2Þ
where Pt is daily price of the bond in time t. 5. Results 5.1. Descriptive results Fig. 1 presents the daily closing prices of the Treasury and Rumelia Railway bonds as well as the starts of wars. The paths of two bond prices are similar. This is not surprising as they can bear the same default risk. On the other hand, the Rumelia Railway bond was much more volatile than the Treasury bond. This could be attributed to the fact that railroads were located in a war zone during the Balkan wars. In the long run, there is a slight decrease in bond prices, which is particularly marked during the outbreak of the First Balkan war and the end of the Turco-Italian wars in October 1912. We observe a strong decrease in the Rumelia Railway bond prices compared to those of the Treasury bond. As the Second Balkan war starts in June 1912, there is a slight reduction in prices. Bond prices recovered before the war ended in August 1913. These reductions during war times imply a positive correlation between default risk of bonds and wars. Bond prices fell prior to the outbreak of the Turco-Italian war. Prices strongly recovered just after the outbreak of the war. Similarly, Fig. 1 indicates a decrease in the prices particularly before the outbreak of the First and Second Balkan wars. Furthermore, a fall in bond prices is observed prior
to the beginning of WWI. These observations indicate an _ increasing war risk perceived by investors at the Istanbul bourse before the wars. 5.2. Identification of break times Table 1 gives the break points for volatility of Treasury and Rumelia Railway bond prices.6 The basis points in column (3) reflect that the magnitude of change in the average bond prices observed after and before the break points. This exercise allows us to examine different effects of war-related events. For instance, the beginning of the Turco-Italian war might have led to a decrease in prices. When a peace treaty between the Ottoman Empire and Italy ended the war, there would be an increase in prices. In both cases, volatility would be high due to capital outflows and inflows. Fig. 2 shows variances for returns of the bonds and corresponding break dates. This information allows us to examine the changes and magnitude of risk perceptions in war-related events that lead to structural breaks. Column (2) of Table 1 reports the five break points detected. The breaks in return variances of the Treasury bond are at the same times as those in the Rumelia Railway bond. It seems that the default risks of the two bonds are similar because both were issued by the Ottoman state. The first break is identified on 21 September 1911. This break point corresponds to eight days before the official start of the Turco-Italian war. The break caused a reduction in the prices of Treasury and Rumelia Railway bonds by 6.38 and 17.13 basis points, respectively. Before the outbreak of the war, different editions of Tanin and Tercu¨man-ı Hakikat reported that the Italian government, press, and diplomats began a lobbying campaign to invade Libya (Tercu¨man-ı Hakikat, 12 September 1911: p. 1; Tercu¨man-ı Hakikat, 18 September 1911: p. 1; Tanin, 12 September 1911: p. 1; Tanin, 19 September 1911: p. 1; Hu¨seyin Cahid, 22 September 1911: p. 1). There had been increasing tension between the Ottoman Empire and Italy since 1905, as Italy desired to control Libya and the Aegean Islands. To this end, even the conversion of an Italian girl to Islam in Athens could turn into an important political problem (Tercu¨man-ı Hakikat, 11 September 1911: p. 1).7 Around midSeptember, news and commentary related to the tensions between the Ottoman Empire and Italy regarding Libya appeared more often. For instance, there were only several news or pieces of commentary in Tanin or Tercu¨man-ı Hakikat between 13 and 31 August, as around twenty news or commentaries were published between 1 and 20 September. 6
In finance literature, the GARCH model is used to check whether break dates have a significant effect on volatility, and hence on financial market instability. To check the robustness of our findings, we use the GARCH (1, 1) model. The findings show that break dates identified by the ICSS test have statistically significant effects on volatility series. In other words, break dates, or events behind the volatility changes, were important in terms of causing _ financial instability in the Istanbul Bourse. 7 See also Kologlu (1999) for the detailed discussion on campaigns in Italy for invading Libya.
€ et al., War-related risks and the Istanbul _ _ Please cite this article in press as: Hanedar, A. O., bourse on the eve of the First World War, Borsa Istanbul Review (2015), http://dx.doi.org/10.1016/j.bir.2015.05.001
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Fig. 1. Prices for Treasury and Rumelia Railway Bonds 1910e14. Note: The price of the Treasury bond is denominated in Kurus‚es while the price of the Rumelia Railway bond is denominated in French Francs. Data source: Tercu¨man-ı Hakikat and Tanin, 1910e1914.
Table 1 Structural break points in variance for returns of Treasury and Rumelia railway bonds (1910e14). Bonds
Break dates
Basis points
Treasury bond
21.09.1911 29.09.1911 17.11.1911 29.02.1912 29.09.1912 21.09.1911 29.09.1911 17.11.1911 29.02.1912 29.09.1912
6.38 6.19 5.50 5.85 9.42 17.13 16.44 13.63 12.20 13.05
Rumelia Railway bond
Note: Table shows the break dates selected by the Inclant-Tiao (1994) test. In column (3), basis points represent the difference between average bond price after and before the break.
In Fig. 2, variances of bond returns begin to increase on 21 September, indicating higher uncertainty and risk as perceived _ by investors at the Istanbul bourse prior to the Turco-Italian war, which led to a decrease in bond prices. We observe another break point on 29 September 1911, the official start of the Turco-Italian war. On 28 September, Italy officially declared its desire to occupy Libya. The Ottoman state rejected this claim, issuing another ultimatum. Italy declared war on the Ottoman Empire on 29 September at 3 p.m. (Tanin, 30 September 1911: p. 1; Beehler, 1913: p. 16). The actual outbreak of the war on 29 September did not affect bond prices at the same day, as the bourse was open between 9.30 a.m. and 3.00 p.m. (Borsa Rehberi-1928, 1990a: p. 141). The probability of war was capitalised by investors in the Ottoman Empire until 29 September, which led to a decrease in bond prices due to higher uncertainty on the
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Fig. 2. Variance in returns of Treasury and Rumelia Railway bonds. Notes: Variances are obtained through moving windowed variance formula with the window length of 5 and 10 days, respectively.
repayments of bonds. This is also reflected in Ottoman newspapers as well. Between 22 and 29 September, around fifty news stories and pieces of commentary in Tanin or Tercu¨man-ı Hakikat covered increasing tensions between the Ottoman Empire and Italy. Interestingly, the decline in bond prices did not differ much from those in the first break point, and they were small in magnitude (6.19 and 16.44, respectively). It seems that investors had already sold the bonds prior to 29 September. In Fig. 2, variance on 29 September is larger than that observed before. It shows that the possibility for the outbreak of the war had led to higher default risk perceptions. As shown in Fig. 1 and 2, bond prices gradually recovered and variances decreased after 29 September, reflecting that
_ investors trading at the Istanbul bourse did not expect a long war that would have caused higher budget deficits and default risk. This is because Italy successfully seized Tripoli in just a few days (Beehler, 1913: p. 20). As discussed by the owner and head columnist of Tanin, Hu¨seyin Cahid (Tanin, 6 October 1911: p. 1), the defeat of the Ottoman Empire caused great disappointment among the Ottomans. The third break is identified on 17 November 1911, one and a half months after the outbreak of the Turco-Italian war. There were 5.50 and 13.63 basis point reductions in the bonds' prices. Fig. 2 indicates an increase in variances. In particular, the variance of return for the Rumelia Railway bond was quite high on 17 November. On 16 November, Tercu¨man-ı Hakikat reported that a huge number of Ottoman soldiers were ready to
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attack the Italian forces in Libya. In this commentary, it is argued that the war would become more severe day by day (Tercu¨man-ı Hakikat, 16 November 1911: p. 1). Another break takes place on 29 February 1912, leading to a reduction in bond prices of Treasury and Rumelia Railway bonds by 5.86 and 12.2 basis points, respectively. Fig. 2 indicates that variances started to increase after 29 February 1912. Commentary in the newspapers reported that the Ottomans were furious at to the Italian attack on Beirut, and the Ottoman state decided to expel Italians residing in Syria after 28 September (Tercu¨man-ı Hakikat, 26 February 1912: p. 1; Beehler, 1913: p. 58). It seems that these events sent a message to investors about the scale and severity of the war. Furthermore, it brought increased uncertainty, risk and serious damage to the Ottoman economy. We observe the final break point on 29 September 1912, before the outbreak of the First Balkan war and the end of the Turco-Italian war. There was a decrease in bond prices by 9.42 and 13.05 basis points. Reduction in bond prices again increased in magnitude on this day. In addition, after 29 September, variances began to rise, and there was a peak on 16 October, as shown in Fig. 2. This shows a larger uncertainty in comparison to those in the other points. Moreover, Fig. 1 indicates a downturn in bond prices that hadn't recovered. This higher uncertainty can be attributed to the current war as well as the expectation of a new war. The break on 29 September 1912 might be related to the prediction of the outbreak of the First Balkan war by investors in the Ottoman Empire. On 27 September, a political and military alliance was signed among the Balkan states against the Ottoman Empire (Beehler, 1913; p. 13). Even one year before, i.e., on 28 September 1911, Tanin underlined a possible conflict between the Ottoman Empire and Greece in the near future due to negotiations between Greece and other Balkan states for an alliance (Tanin, 28 September 1911: p. 1). On 27 September 1912, a commentary reported that Bulgaria had begun recruiting reserve force soldiers, which led to an expectation that Bulgaria would soon declare war against the Ottoman Empire (Tanin, 27 September 1912: p. 1). Additionally, on 28 September, a commentary in Tanin reported that an Italian fleet sailed into the Gulf of Izmir, delaying peace negotiations that had been launched by the Great Powers in March 1912 (Tanin, 28 September 1912: p. 1). As expected, peace negotiations were delayed in October (Beehler, 1913: p. 95). Subsequently, the Ottoman state imposed additional taxes to fund its war expenditures (Beehler, _ 1913: p. 82). It seems that investors trading at the Istanbul bourse had predicted that the Turco-Italian war would not end quickly and that the Ottoman state would be in financial trouble. Hence, our findings indicate higher perceived uncertainty and default risk after the breakdown of peace talks. 6. Conclusions Financial markets are highly sensitive to news dissemination. This idea is based on the fact that investors take positions in case of important news to avoid losses in bond markets.
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News such as wars can lead to price changes through capital outflows and changes in investment strategies. Hence, an investigation of sudden price changes reveals information about the timeline of reactions leading to structural changes. Based on the historical data for the prices of Ottoman government bonds, we argue that large fluctuations in bond prices can provide information on how bondholders in the Ottoman Empire reacted to unanticipated events. Our empirical findings identify five break points that corresponded to events about the Turco-Italian war and the First Balkan war. Bond prices began to fall considerably on 21 September 1911 as there was a significant increase in variances. The break point occurred one week before the war between the Ottoman Empire and Italy started. The bond price experienced another large fall on 29 September 1911 when the war began. There were two other break points observed on 17 November 1911 and 29 February 1912 related to events in the Turco-Italian war. Another break is identified on 29 September 1912, just before the end of the Turco-Italian war and prior to the outbreak of the First Balkan war. News and commentary in the Ottoman newspapers often included negative messages, reflecting that war would be possible in the near future. For investors, that meant higher default risk, which led to lower prices for government bonds due to capital outflows, as volatility increased. During wars in our sample, the Ottoman Empire experienced an increasing debt burden due to military expenditures. The Ottoman state began to borrow at high rates during these times. The interest rate for long-term borrowing increased from 4 percent in 1911 to 5 percent in 1914 (Kıray, 1995: pp. 213e21). These rate _ increases indicate why bondholders at the Istanbul bourse considered war as a source of risk, reflected by decreasing _ prices. Accordingly, it can be argued that the Istanbul bourse was sensitive to the political crises of 1910e1914, in contrast to Ferguson's (2006) study on the London bourse. This could be related to the fact that the political crises heralded the onset of WWI, the decline of the Ottoman Empire, and many economic problems such as inflation, and a decrease in trade and _ production. It seems that the price changes on the Istanbul bourse were informative for the Ottoman politicians, whom the war caught unaware, allowing them to successfully anticipate the economic results of war. This paper could lead to further research if detailed data on the number of bonds in circulation, volume of trade, and investor profiles in the Ottoman Empire were to be found, as _ this information would help to characterize the Istanbul bourse. References _ Akyıldız, A. (2001). Osmanlı D€onemi Tahvil ve Hisse Senetleri. Istanbul: Tu¨rk Ekonomi Bankası. Bai, J., & Perron, P. (1998). Estimating and testing linear models with multiple structural changes. Econometrica, 66(1), 47e78. Bai, J., & Perron, P. (2003). Computation and analysis of multiple structural change models. Journal of Applied Econometrics, 18(1), 1e12. Basdas, U., & Oran, A. (2014). Event studies in Turkey. Borsa Istanbul Review, 14(3), 167e188.
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Beehler, W. H. (1913). The History of the Italian-Turkish War, September 29, 1911 to October 18, 1912. U.S.: Annapolis. _ _ Borsa Rehberi-1928. (1990a). Volume 1. Istanbul: Istanbul Menkul Kıymetler Borsası. Borsa Rehberi-1928. (1990b). Osmanlı D€onemi borsa ve mali sistemi (Vol. 2). _ _ Istanbul: Istanbul Menkul Kıymetler Borsası. Brown, W. O., & Burdekin, R. C. K. (2000). Turning points in the U.S. Civil war: a British perspective. The Journal of Economic History, 6(1), 216e231. Brown, W. O., & Burdekin, R. C. K. (2002). German debt traded in London during the Second World War: a British perspective on Hitler. Economica, 69(276), 655e669. Bulgaristanda tedarikat. Tanin, (27 September 1912), 1. _ _ ‚kileri. Childs, T. G. (2008). Trablusgarp Savas‚ı ve Tu¨rk-Italyan Diplomatik Ilis _ _ ‚ Bankası Ku¨ltu¨r Yayınları. Deniz Berktay (Translated). Istanbul: Is Elmendorf, D. W., Hirschfeld, M. L., & Weil, D. N. (1996). The effect of news on bond prices: evidence from the United Kingdom, 1900e1920. Review of Economics and Statistics, 78(2), 341e344. Erickson, E. J. (2001). Order to die: A history of the Ottoman Army in the First World War. London: Greenwood Press. Ferguson, N. (2006). Political risk and the international bond market between the 1848 revolution and the outbreak of the First World War. The Economic History Review, New Series, 59(1), 70e112. _ _ Fertekligil, A. (2000). Tu¨rkiye'de Borsa'nın Tarihçesi. Istanbul: Istanbul Menkul Kıymetler Borsası. Fırsattan istifade kaydına du¨s‚mu¨s‚ler. Tanin, (28 September 1911), 1. Frey, B. S., & Kucher, M. (2000). World War II as reflected on capital markets. Economics Letters, 69, 187e191. Frey, B. S., & Kucher, M. (2001). Wars and markets. How bond values reflect the Second World War. Economica, 68, 317e333. _ Galata Borsası-Osmanlı Eshamı. Ikdam, (25 September 1911), 1. Geyikda gı, V. N. (2011). Foreign investment in the Ottoman Empire: international trade and relations, 1854e1914. London: Tauris Academic Studies. _ _ Giolitti, G. (2012). D€ onemin Italya Bas‚bakanının, Tu¨rk-Italyan Savas‚ı'na Dair Hatıraları, Trablusgarpı' Nasıl Aldık. Tahsin Yıldırım (Translated). _ Istanbul: DBY yayınları. Hall, R. C. (2000). The Balkan Wars 1912e1913, prelude to the First World War. London: Routledge. Henig, R. (2002). The origins of the First World War. London: Routledge. Herrmann, D. G. (1989). The paralysis of Italian strategy in the Italian-Turkish War, 1911e1912. The English Historical Review, 104, 332e356. Ho, C., & Li, D. (2014). A mirror of history: China's bond market, 1921e42. Economic History Review, 67(2), 409e434. Hu¨seyin Cahid, Ne bekliyoruz?. Tanin, (6 October 1911), 1. Hu¨seyin Cahid, Trablusgarb. Tanin, (22 September 1911), 1. _ ¨ lku¨, N. (2012). Political risk and Foreigners' trading: evidence Ikizlerli, D., & U from an emerging stock market. Emerging Markets Finance and Trade, 48(3), 106e121.
Inclan, C., & Tiao, G. (1994). Use of the cumulative sums of squares for retrospective detection of changes of variance. Journal of the American Statistical Association, 89, 913e923. _ Italya Trablusgarb. Tercu¨man-ı Hakikat, (12 September 1911), 1. Karpat, K. (2002). Studies on Ottoman social and political history: selected articles and essays. Leiden: Brill. Kati bir harb muhakkaktır. Tercu¨man-ı Hakikat, (16 November 1911), 1. _ _ _ Kazgan, H. (1995). Tarih Boyunca Istanbul Borsası. Istanbul: Istanbul Menkul Kıymetler Borsası. Kazgan, H., Ates‚, T., Tekin, O., Koraltu¨rk, O., Soyak, A., Eroglu, N., et al. (Eds.). (1999). Turkish financial history from the Ottoman Empire to the _ _ present (Vol. 1). Istanbul: Istanbul Stock Exchange. _ _ Kologlu, O. (1999). Osmanlı-Italyan Libya Savas‚ında Ittihatçılar, Masonlar ve ¨ mit yayıncılık. Sosyalist Enternasyonal. Ankara: U _ _ ‚im Kıray, E. (1995). Osmanlı'da Ekonomik Yapı ve Dıs‚ Borçlar. Istanbul: Iletis yayınları. Mauro, P., Sussman, N., & Yafeh, Y. (2006). Emerging markets and financial globalization: Sovereign bond spreads in 1870e1913 and today. Oxford: Oxford University Press. Muharebe. Tercu¨man-ı Hakikat, (26 February 1912), 1. € Onder, Z., & S¸imga-Mugan, C. (2006). How do political and economic news affect emerging markets? Evidence from Argentina and Turkey. Emerging Markets Finance and Trade, 42(4), 50e77. Oosterlinck, K. (2003). The bond market and the legitimacy of Vichy France. Explorations in Economic History, 40(3), 326e344. € ¨ ksel, M. (2014). The Hejaz Railway and the Ottoman Empire: Modernity, Ozyu industrialisation and Ottoman decline. London: I. B. Tauris & Co Ltd. Rigobon, R., & Sack, B. (2005). The effects of war risk on US financial markets. Journal of Banking & Finance, 29(7), 1769e1789. Sulh mu¨zakeratı. Tanin, (28 September 1912), 1. Tanin, (30 September 1911), 1. Toprak, Z. (2008). The financial structure of the stock exchange in the late Ottoman Empire. In P. L. Cottrell, M. Pohle, & I. L. Fraser (Eds.), East meets west: Banking, commerce and investment in the Ottoman Empire (pp. 143e161). Hampshire: Ashgate Publishing Limited. _ Trablusgarb-Italya. Tanin, (12 September 1911), 1. _ Trablusgarb-Italya. Tanin, (19 September 1911), 1. Trablusgarb içu¨n. Tercu¨man-ı Hakikat, (18 September 1911), 1. Tunçer, A.Ç. (2009). Institutions, sovereign risk and taxation: International financial control in the Ottoman Empire, Greece and Egypt. The Economic History Society Working Paper. _ Veliahtın seyahatı, Trablus ve Iran. Tercu¨man-ı Hakikat, (11 September 1911), 1. Waldenstr€om, D., & Frey, B. S. (2008). Did Nordic countries recognize the gathering storm of World War II? Evidence from the bond markets. Explorations in Economic History, 45(2), 107e126. Willard, K. L., Guinnane, T. W., & Rosen, H. S. (1996). Turning points in the Civil War: views from the Greenback Market. American Economic Review, 86, 1001e1018. _ Yeniay, I. H. (1964). Yeni Osmanlı Borçları Tarihi. Istanbul: Ekin basımevi.
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_ War-related risks and the Istanbul bourse on the eve of the First World War* € Avni Onder Hanedar a,*, Erdost Torun a,b, Elmas Yaldız Hanedar c _ Dokuz Eylu¨l University, Faculty of Business, Izmir, Turkey Academia Sinica, Institute of Economics, Taipei, Taiwan c _ Yeditepe University, Faculty of Economics and Administrative Sciences, Istanbul, Turkey a
b
Received 18 September 2014; revised 23 May 2015; accepted 23 May 2015 Available online ▪ ▪ ▪
Abstract The lack of well-documented information in the historical literature on the relationship between war-related expectations and their effects on the bond market in the Ottoman Empire motivates this paper's three contributions. First, this paper is the first empirical study to investigate the break points in the volatility of Ottoman bond prices from a historical point of view. Second, we use the econometric technique developed by Inclan and Tiao (1994) to identify the structural breaks. Last, we use a manually collected dataset from the daily newspapers of the time on daily Ottoman bond prices from 1910 to 1914. Subsequently, we identify five structural break dates, each of them corresponding to important warrelated events. When we investigate the commentaries in the Ottoman newspapers, we see that the outbreak of several wars might not have been a surprise for investors in the Ottoman Empire, as reflected by government bond prices. _ Copyright © 2015, Borsa Istanbul Anonim S¸irketi. Production and hosting by Elsevier B.V. This is an open access article under the CC BY-NCND license (http://creativecommons.org/licenses/by-nc-nd/4.0/). JEL classification: G1; N25; N45 Keywords: The Turco-Italian war; Ottoman government bonds; Inclan-Tiao test
1. Introduction Recent studies on today's Turkey show that financial markets have often been affected by the political events (Basdas & Oran, € _ ¨ lku¨, 2012). 2014; Onder & S¸imga-Mugan, 2006; Ikizlerli &U Specifically, government bond prices are related to fiscal deficits. As the fiscal deficit rises, the value of a government bond drops and its yield rises due to high default risk; leading to an increased cost of borrowing for the government. The outbreak of a war would be interpreted as negative news since it implies budget deficits, higher interest rates, and higher default risk of governments (Ferguson, 2006). Accordingly, war-related * We would like to thank the two anonymous referees for their suggestions. We are also grateful for feedback, support, and helpful comments by Necla Geyikda gı, S¸evket Pamuk, Ragıp Yılmaz, participants of AGDES¸ seminar and students at the Turkish Military Academy. * Corresponding author. Dokuz Eylu¨l University, Faculty of Business, _ Kaynaklar Yerles‚kesi, 35160 Buca, Izmir, Turkey. Tel.: þ90 5393453073. € Hanedar). E-mail address: [email protected] (A.O. _ Peer review under responsibility of Borsa Istanbul Anonim Sirketi.
expectations change the behaviour of investors to avoid losses or make profits, which leads to structural breaks in the volatility of bond prices. Several papers have examined the effects of wars on bond markets in the US, Europe and China (Brown & Burdekin, 2000; Brown & Burdekin, 2002; Frey & Kucher, 2000, 2001; Ho & Li, 2014; Oosterlinck, 2003; Rigobon & Sack, 2005; Waldenstr€om & Frey, 2008; Willard, Guinnane, & Rosen, 1996). These studies have focused on the recent IraqUS war, the American Civil War and most of all on the Second World War. In addition, two papers have investigated the effects of WWI on European asset prices. Elmendorf, Hirschfeld, and Weil (1996) found that war news during WWI affected the variances of returns on British government bonds. Ferguson (2006) did not identify an important increase in war risk during the political crises of 1880e1914, which would have led to substantial change in yields for bonds of Great Powers1 traded on the London bourse. However, there is 1
The UK, Italy, Germany, Austria-Hungary, and Russia.
http://dx.doi.org/10.1016/j.bir.2015.05.001 _ 2214-8450/Copyright © 2015, Borsa Istanbul Anonim S¸irketi. Production and hosting by Elsevier B.V. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/). € et al., War-related risks and the Istanbul _ _ Please cite this article in press as: Hanedar, A. O., bourse on the eve of the First World War, Borsa Istanbul Review (2015), http://dx.doi.org/10.1016/j.bir.2015.05.001
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no well-documented information on the relationship between war-related risks and the bond market in the Ottoman Empire. Between 1910 and 1914, the Ottoman Empire was involved in four wars: the Turco-Italian, the First Balkan, the Second Balkan, and the First World War (WWI), all of which led to high war expenditures and an increased debt burden of the Ottoman Empire.2 The Turco-Italian war started on 29 September 1911, as Italy presented an ultimatum to occupy Libya. During September 1911, Ottoman newspapers often featured news related to the desire of Italian nationalists and newspapers to seize Libya. As the Ottoman state believed that Germany would have prevented such an attack (Beehler, 1913: p. 16; Herrmann, 1989: pp. 337e8), the Turco-Italian war caught the Ottoman government unprepared (Childs, 2008: p. 72; Giolitti, 2012: p. 59). Similarly, Hall (2000: p. 14) maintains that the Ottoman state considered the outbreak of a war with the Balkan states to be a low risk. In fact, although Bulgaria was improving its military capacity prior to the First Balkan war, the Ottoman state did not recruit soldiers in response (Tanin, 27 September 1912: p. 1). The Second Balkan war officially broke out on 29 June 1913 with Bulgaria's surprise attack on Serbia (Erickson, 2001: p. 3). With the assassination of Archduke Franz Ferdinand by a Serbian nationalist on 28 June 1914, ongoing tensions related to the former wars increased, leading to the outbreak of WWI (Henig, 2002: pp. 15e6; Erickson, 2001: p. 25; Ferguson, 2006). The aim of this paper is to shed light on the existence of war-related expectations prior to wars in the Ottoman Empire from 1910 to 1914. To this end, we estimate structural break points in variances of government bonds due to the war threats and risks perceived by bondholders in the Ottoman Empire with a specific focus on the fluctuations in prices of government bonds traded on the _ Istanbul bourse between 1910 and 1914. We use the econometric method developed by Inclan and Tiao (1994) to identify the structural breaks in the volatility of bond prices. This method allows endogeneous selection of break points without using any prior information. The vast majority of finance studies use Inclan and Tiao's (1994) test instead of Bai and Perron's (1998, 2003) method, as financial instability and hence risk could be identified with breaks in volatility rather than sudden changes in price series. A review of literature seems to indicate that, our paper is the first study to use this methodology in a historical context. We use daily observations of Treasury and Rumelia Railway _ bond prices traded on the Istanbul bourse from 1910 to 1914. We collected these data manually from Ottoman newspapers, which have never been used before to empirically examine the 2
The Ottoman Empire joined WWI in November 1914, but we were only able to extend our sample until July 1914 as there were no available data up to November 1914. 3 Several studies have used data for the Ottoman government bonds traded in Europe, such as Mauro, Sussman, and Yafeh (2006) and Tunçer (2009). In contrast to these researches, using manually collected daily prices from the Ottoman newspapers, our paper is the first to examine whether threats and _ risks due to the wars between 1910 and 1914 were forecasted at the Istanbul bourse.
_ war-related information flow into the Istanbul bourse.3 The _ data also allowed us to examine how the Istanbul bourse perceived war-related risks. In addition to the methodology used in the paper, the novelty of this dataset can be regarded as one of the most important contributions of our paper. The case we examine is informative for understanding the _ reaction of the Istanbul bourse to the war threats. Our findings show that bond price variances included break points that coincided with the Turco-Italian and the First Balkan wars. In addition, prior to the outbreak of these wars, there was a significant _ war expectation among the investors at the Istanbul bourse, which led to lower bond prices. This is in line with the arguments _ _ of a commentary in Ikdam, a widely read newspaper in Istanbul, on the negative relationship between war-related news dissemination and the demand of the bondholders for Ottoman gov_ ernment bonds (Ikdam, 25 September 1911: p. 1). The financial situation of the Ottoman Empire worsened before the wars (Geyikdagı, 2011: pp. 119e26), as budget deficits increased due to war expenditures (Beehler, 1913: p. 82). The results therefore imply that the Ottoman state did not anticipate these wars that did not come as a surprise, in contrast to the investors trading at the _ Istanbul bourse who would have lost money. The remainder of this paper is organized as follows. The _ next section presents the historical background of the Istanbul bourse, government bonds, and news dissemination in the Ottoman Empire. Section 3 and 4 provide information on the data and model. Section 5 presents the empirical results, before the conclusions. _ 2. The Istanbul bourse, government bonds, and news After the Crimean War (1853e1856), the financial situation of the Ottoman Empire worsened. The Ottoman state borrowed from abroad, and a treasury bond, the Konsolid bond, was issued. The bond was traded over the counter in Galata, _ Istanbul, and also on the Paris and London bourses. Furthermore, investors in the Ottoman Empire invested in shares of European joint-stock firms before the foundation of a formal market (Borsa Rehberi-1928, 1990a: pp. 15e6; Kazgan et al., 1999: pp. 371e75; Fertekligil, 2000: pp. 15, 23). Over time, many joint-stock companies were founded, and new government bonds were issued by the Ottoman state. To regulate the growing market, a bourse to exchange bonds, stocks, and foreign currencies was officially established by the Ottoman _ state in 1866, known as the “Istanbul Bond Market” (Dersaadet Tahvilat Borsası). The bourse regulations were copied from the European bourses (Kazgan, 1995: p. 67; Kazgan et al., 1999: p. 375; Fertekligil, 2000: p. 26; Toprak, 2008: p. 151). In the 1870s, eight financial assets were traded on the bourse, including treasury bonds of the Ottoman state and foreign bonds, e.g., the Bosporus Navigation Company's bond (S¸irket-i Hayriye). After 1908, Ottoman citizens were permitted to found joint-stock firms. The number of joint-stock and limited companies established in the Ottoman Empire increased from four in 1908 to twenty-four in 1910. Consequently, new domestic bonds and stocks were issued. As of 1914, one hundred and four bonds and stocks were issued by
€ et al., War-related risks and the Istanbul _ _ Please cite this article in press as: Hanedar, A. O., bourse on the eve of the First World War, Borsa Istanbul Review (2015), http://dx.doi.org/10.1016/j.bir.2015.05.001
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the Ottoman state as well as by foreign and domestic companies (Kazgan et al., 1999: p. 344; Fertekligil, 2000: pp. 44e5). Studies on the bond markets of different countries show that wars signify negative news about the future of governments, leading to lower government bond prices (e.g., Frey & Kucher, 2000, 2001; Ferguson, 2006; Ho & Li, 2014; Waldenstr€om & _ Frey, 2008). Similarly, a commentary in Ikdamdan Ottoman newspaperdargued that on 23 September 1911 the prices of government bonds were negatively affected by news about Italy's desire to invade Libya. The prices recovered on 24 September after investors believed that this news was _ misleading (Ikdam, 25 September 1911: p. 1). This commentary shows how quickly war-related news disseminated to investors in the Ottoman Empire, which affected bond prices. 3. Data We use the closing price data of the Treasury and the Rumelia Railway bonds because there is not much information on the prices of the other government bonds. It should be noted that the historical literature does not provide clear information about the turnover and investor _ profile on the Istanbul bourse. According to several sources, such as Borsa Rehberi-1928 (1990b: p. 337), Kazgan (1995: p. 95) and Fertekligil (2000: p. 82), the Treasury and the Rumelia Railway bonds were the biggest and the most frequently traded _ government bonds on the Istanbul bourse. The total debts collected with those bonds were 42,275,772 and 79,200,000 Turkish Liras, respectively. These were the highest figures in Ottoman foreign debt. With dreams of becoming rich, even ordinary people living in different parts of the Ottoman Empire traded at the bourse and bought a large amount of these government bonds. Government officers and members of the Ottoman dynasty constituted an important fraction of the bondholders. Non-Muslim citizens of the Ottoman Empire, bankers, and foreign banks were also important bondholders due to their links with European finance capitals. In addition, foreign investors, and even Allied soldiers during the occupation years had already invested in these bonds (Kazgan, 1995: pp. 95, 106; Kazgan et al., 1999: pp. 375, 406; Fertekligil, 2000: pp. 82, 89e90, 102e3). Moreover, the Rumelia Railway bond was called the Turkish Lottery bond, as it included € ¨ ksel, 2014: p. 16). lottery prizes to attract small investors (Ozyu The bond price data come from available volumes of Tercu¨man-ı Hakikat and Tanin. The major source is Tercu¨man-ı Hakikat, which had many available issues. By the end of the nineteenth century, Tercu¨man-ı Hakikat was a widely circu_ lated daily Ottoman newspaper in Istanbul, according to Karpat (2002: pp. 269e70). We used Tanin as an alternative source when several issues of Tercu¨man-ı Hakikat could not be found. In addition, bond prices were not reported in some issues. Tercu¨man-ı Hakikat, the first issue of which was published in 1878, was an opposition newspaper. Tanin was established as a pro-government newspaper; however, after 1911 it criticized the Ottoman government harshly and was closed down. Those newspapers had a column on the opening and closing prices of several bonds. The National Library of
3
Turkey and the Beyazıt State Library provide digital copies of these newspapers. From these sources, we manually extracted data that have not been used before. In the newspapers, bond prices were only reported for the period between 2 November 1910 and 31 July 1914.4 The Treasury bond was a consolidated bond that replaced the earlier bonds except the Rumelia Railway bond. 1,488,126 consolidated bonds, which had a face value of 22 Ottoman Liras, were issued on 1 September and 14 September 1908. The rate of interest on the Treasury bond was 4 percent (Yeniay, 1964: pp. 90e1; Borsa Rehberi-1928, 1990a: p. 153, 1990b: p. 100). There is no detailed information on the maturity date of the bond, as similar bonds issued in these years were to be repaid between 50 and 100 years (Yeniay, 1964). In the data sources, the bond price is denominated in Kurus‚es. The bond could also be bought in British Pounds or French Francs (Yeniay, 1964: p. 91). The Rumelia Railway bond was issued by the Ottoman state to fund railroad building in the European part of the Ottoman Empire. The Ottoman state would have paid money in French Francs to the railroad building company of Baron de Hirsch. This probably explains why the face value of this bond was 400 French Francs. 1,980,000 bonds with a 104-year maturity were offered to the public on 10 March 1870 and 12 September 1872. The yield of these Rumelia Railway bonds was 3 percent (Yeniay, 1964: pp. 43e4; Borsa Rehberi-1928, 1990b: pp. 83e6; Akyıldız, 2001: p. 106). The Rumelia Railway bond is denominated in French Francs in the data sources. Because the exchange rates were constant over the sample period, we do not need to convert the price of the Rumelia Railway bond into Kurus‚es. 4. Methodology We identify the break points in the volatility of the Ottoman government bond prices by using an Iterative Cumulative Sums of Squares (ICSS) algorithm as proposed by Inclan and Tiao (1994). Recently, Waldenstr€om and Frey (2008) used Bai and Perron's (1998, 2003) method to examine the effects of warrelated risks in Nordic countries during the Second World War, identifying breaks in bond yields. Inclan and Tiao (1994) suggest that the sudden change in variance or volatility is a better measure of risk perceived by bondholders rather than breaks in bond prices. So, ICSS is superior to Bai and Perron's (1998, 2003) method. ICSS is a nonparametric method5 and endogenously determines the break points by using squared price changes, 4 It should be noted that our results may alter if the sample period had started from another year. Different break points could have been detected because of periodization. For instance, if the sample period started in 1907, then we could have identified break points in 1908 as there were several important political events, e.g., the annexation of Bosnia-Herzegovina by AustriaeHungary, which could have led to higher volatility in Ottoman bond prices due to the possibility of the outbreak of a war. 5 We also identify break dates by using Bai and Perron's (1998, 2003) method. As this is a parametric method, the findings vary due to the different data distribution assumption and estimation methods, in contrast to those of the ICSS test. That is the one of the reasons why we prefer using the ICSS.
€ et al., War-related risks and the Istanbul _ _ Please cite this article in press as: Hanedar, A. O., bourse on the eve of the First World War, Borsa Istanbul Review (2015), http://dx.doi.org/10.1016/j.bir.2015.05.001
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which does not require any prior information on the distribution of series and the timing and existence of breaks. Moreover, ICSS does not require an exogenous selection for the maximum number of break points, in contrast to Bai and Perron's (1998, 2003) method. ICSS assumes that a time series of interest has a variance interrupted by an unknown number of sudden changes. To estimate both the number and the time point of changes in variance, ICSS uses the centred (and normalized) cumulative sum of squares statistic defined as: Dk ¼ ðCk = þ CT Þ ðk=TÞ k ¼ 1;…;T with D0 ¼ Dk ¼ 0 ð1Þ P where T is the number of observations. Ck ¼ kt¼1 ε2t denotes the cumulative sum of squared observations from start of the series until the kth point in time. The plot of the Dk statistic against k oscillates around zero for the observations having homogenous variance with no sudden changes. As a sudden change takes place in variance, the plot of Dk exhibits a pattern going out of some specified boundaries with high probability. ICSS is based on detecting maximum deviation from these boundaries. If the maximum value of jDk j is greater than the critical value, the null hypothesis of no change can be rejected. Prices of government bonds may not be stationary, which may lead to biased test statistics. To this end, we use returns of government bonds, which are estimated by the following formula: Rt ¼ lnðPt =Pt1 Þ
ð2Þ
where Pt is daily price of the bond in time t. 5. Results 5.1. Descriptive results Fig. 1 presents the daily closing prices of the Treasury and Rumelia Railway bonds as well as the starts of wars. The paths of two bond prices are similar. This is not surprising as they can bear the same default risk. On the other hand, the Rumelia Railway bond was much more volatile than the Treasury bond. This could be attributed to the fact that railroads were located in a war zone during the Balkan wars. In the long run, there is a slight decrease in bond prices, which is particularly marked during the outbreak of the First Balkan war and the end of the Turco-Italian wars in October 1912. We observe a strong decrease in the Rumelia Railway bond prices compared to those of the Treasury bond. As the Second Balkan war starts in June 1912, there is a slight reduction in prices. Bond prices recovered before the war ended in August 1913. These reductions during war times imply a positive correlation between default risk of bonds and wars. Bond prices fell prior to the outbreak of the Turco-Italian war. Prices strongly recovered just after the outbreak of the war. Similarly, Fig. 1 indicates a decrease in the prices particularly before the outbreak of the First and Second Balkan wars. Furthermore, a fall in bond prices is observed prior
to the beginning of WWI. These observations indicate an _ increasing war risk perceived by investors at the Istanbul bourse before the wars. 5.2. Identification of break times Table 1 gives the break points for volatility of Treasury and Rumelia Railway bond prices.6 The basis points in column (3) reflect that the magnitude of change in the average bond prices observed after and before the break points. This exercise allows us to examine different effects of war-related events. For instance, the beginning of the Turco-Italian war might have led to a decrease in prices. When a peace treaty between the Ottoman Empire and Italy ended the war, there would be an increase in prices. In both cases, volatility would be high due to capital outflows and inflows. Fig. 2 shows variances for returns of the bonds and corresponding break dates. This information allows us to examine the changes and magnitude of risk perceptions in war-related events that lead to structural breaks. Column (2) of Table 1 reports the five break points detected. The breaks in return variances of the Treasury bond are at the same times as those in the Rumelia Railway bond. It seems that the default risks of the two bonds are similar because both were issued by the Ottoman state. The first break is identified on 21 September 1911. This break point corresponds to eight days before the official start of the Turco-Italian war. The break caused a reduction in the prices of Treasury and Rumelia Railway bonds by 6.38 and 17.13 basis points, respectively. Before the outbreak of the war, different editions of Tanin and Tercu¨man-ı Hakikat reported that the Italian government, press, and diplomats began a lobbying campaign to invade Libya (Tercu¨man-ı Hakikat, 12 September 1911: p. 1; Tercu¨man-ı Hakikat, 18 September 1911: p. 1; Tanin, 12 September 1911: p. 1; Tanin, 19 September 1911: p. 1; Hu¨seyin Cahid, 22 September 1911: p. 1). There had been increasing tension between the Ottoman Empire and Italy since 1905, as Italy desired to control Libya and the Aegean Islands. To this end, even the conversion of an Italian girl to Islam in Athens could turn into an important political problem (Tercu¨man-ı Hakikat, 11 September 1911: p. 1).7 Around midSeptember, news and commentary related to the tensions between the Ottoman Empire and Italy regarding Libya appeared more often. For instance, there were only several news or pieces of commentary in Tanin or Tercu¨man-ı Hakikat between 13 and 31 August, as around twenty news or commentaries were published between 1 and 20 September. 6
In finance literature, the GARCH model is used to check whether break dates have a significant effect on volatility, and hence on financial market instability. To check the robustness of our findings, we use the GARCH (1, 1) model. The findings show that break dates identified by the ICSS test have statistically significant effects on volatility series. In other words, break dates, or events behind the volatility changes, were important in terms of causing _ financial instability in the Istanbul Bourse. 7 See also Kologlu (1999) for the detailed discussion on campaigns in Italy for invading Libya.
€ et al., War-related risks and the Istanbul _ _ Please cite this article in press as: Hanedar, A. O., bourse on the eve of the First World War, Borsa Istanbul Review (2015), http://dx.doi.org/10.1016/j.bir.2015.05.001
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5
Fig. 1. Prices for Treasury and Rumelia Railway Bonds 1910e14. Note: The price of the Treasury bond is denominated in Kurus‚es while the price of the Rumelia Railway bond is denominated in French Francs. Data source: Tercu¨man-ı Hakikat and Tanin, 1910e1914.
Table 1 Structural break points in variance for returns of Treasury and Rumelia railway bonds (1910e14). Bonds
Break dates
Basis points
Treasury bond
21.09.1911 29.09.1911 17.11.1911 29.02.1912 29.09.1912 21.09.1911 29.09.1911 17.11.1911 29.02.1912 29.09.1912
6.38 6.19 5.50 5.85 9.42 17.13 16.44 13.63 12.20 13.05
Rumelia Railway bond
Note: Table shows the break dates selected by the Inclant-Tiao (1994) test. In column (3), basis points represent the difference between average bond price after and before the break.
In Fig. 2, variances of bond returns begin to increase on 21 September, indicating higher uncertainty and risk as perceived _ by investors at the Istanbul bourse prior to the Turco-Italian war, which led to a decrease in bond prices. We observe another break point on 29 September 1911, the official start of the Turco-Italian war. On 28 September, Italy officially declared its desire to occupy Libya. The Ottoman state rejected this claim, issuing another ultimatum. Italy declared war on the Ottoman Empire on 29 September at 3 p.m. (Tanin, 30 September 1911: p. 1; Beehler, 1913: p. 16). The actual outbreak of the war on 29 September did not affect bond prices at the same day, as the bourse was open between 9.30 a.m. and 3.00 p.m. (Borsa Rehberi-1928, 1990a: p. 141). The probability of war was capitalised by investors in the Ottoman Empire until 29 September, which led to a decrease in bond prices due to higher uncertainty on the
€ et al., War-related risks and the Istanbul _ _ Please cite this article in press as: Hanedar, A. O., bourse on the eve of the First World War, Borsa Istanbul Review (2015), http://dx.doi.org/10.1016/j.bir.2015.05.001
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Fig. 2. Variance in returns of Treasury and Rumelia Railway bonds. Notes: Variances are obtained through moving windowed variance formula with the window length of 5 and 10 days, respectively.
repayments of bonds. This is also reflected in Ottoman newspapers as well. Between 22 and 29 September, around fifty news stories and pieces of commentary in Tanin or Tercu¨man-ı Hakikat covered increasing tensions between the Ottoman Empire and Italy. Interestingly, the decline in bond prices did not differ much from those in the first break point, and they were small in magnitude (6.19 and 16.44, respectively). It seems that investors had already sold the bonds prior to 29 September. In Fig. 2, variance on 29 September is larger than that observed before. It shows that the possibility for the outbreak of the war had led to higher default risk perceptions. As shown in Fig. 1 and 2, bond prices gradually recovered and variances decreased after 29 September, reflecting that
_ investors trading at the Istanbul bourse did not expect a long war that would have caused higher budget deficits and default risk. This is because Italy successfully seized Tripoli in just a few days (Beehler, 1913: p. 20). As discussed by the owner and head columnist of Tanin, Hu¨seyin Cahid (Tanin, 6 October 1911: p. 1), the defeat of the Ottoman Empire caused great disappointment among the Ottomans. The third break is identified on 17 November 1911, one and a half months after the outbreak of the Turco-Italian war. There were 5.50 and 13.63 basis point reductions in the bonds' prices. Fig. 2 indicates an increase in variances. In particular, the variance of return for the Rumelia Railway bond was quite high on 17 November. On 16 November, Tercu¨man-ı Hakikat reported that a huge number of Ottoman soldiers were ready to
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attack the Italian forces in Libya. In this commentary, it is argued that the war would become more severe day by day (Tercu¨man-ı Hakikat, 16 November 1911: p. 1). Another break takes place on 29 February 1912, leading to a reduction in bond prices of Treasury and Rumelia Railway bonds by 5.86 and 12.2 basis points, respectively. Fig. 2 indicates that variances started to increase after 29 February 1912. Commentary in the newspapers reported that the Ottomans were furious at to the Italian attack on Beirut, and the Ottoman state decided to expel Italians residing in Syria after 28 September (Tercu¨man-ı Hakikat, 26 February 1912: p. 1; Beehler, 1913: p. 58). It seems that these events sent a message to investors about the scale and severity of the war. Furthermore, it brought increased uncertainty, risk and serious damage to the Ottoman economy. We observe the final break point on 29 September 1912, before the outbreak of the First Balkan war and the end of the Turco-Italian war. There was a decrease in bond prices by 9.42 and 13.05 basis points. Reduction in bond prices again increased in magnitude on this day. In addition, after 29 September, variances began to rise, and there was a peak on 16 October, as shown in Fig. 2. This shows a larger uncertainty in comparison to those in the other points. Moreover, Fig. 1 indicates a downturn in bond prices that hadn't recovered. This higher uncertainty can be attributed to the current war as well as the expectation of a new war. The break on 29 September 1912 might be related to the prediction of the outbreak of the First Balkan war by investors in the Ottoman Empire. On 27 September, a political and military alliance was signed among the Balkan states against the Ottoman Empire (Beehler, 1913; p. 13). Even one year before, i.e., on 28 September 1911, Tanin underlined a possible conflict between the Ottoman Empire and Greece in the near future due to negotiations between Greece and other Balkan states for an alliance (Tanin, 28 September 1911: p. 1). On 27 September 1912, a commentary reported that Bulgaria had begun recruiting reserve force soldiers, which led to an expectation that Bulgaria would soon declare war against the Ottoman Empire (Tanin, 27 September 1912: p. 1). Additionally, on 28 September, a commentary in Tanin reported that an Italian fleet sailed into the Gulf of Izmir, delaying peace negotiations that had been launched by the Great Powers in March 1912 (Tanin, 28 September 1912: p. 1). As expected, peace negotiations were delayed in October (Beehler, 1913: p. 95). Subsequently, the Ottoman state imposed additional taxes to fund its war expenditures (Beehler, _ 1913: p. 82). It seems that investors trading at the Istanbul bourse had predicted that the Turco-Italian war would not end quickly and that the Ottoman state would be in financial trouble. Hence, our findings indicate higher perceived uncertainty and default risk after the breakdown of peace talks. 6. Conclusions Financial markets are highly sensitive to news dissemination. This idea is based on the fact that investors take positions in case of important news to avoid losses in bond markets.
7
News such as wars can lead to price changes through capital outflows and changes in investment strategies. Hence, an investigation of sudden price changes reveals information about the timeline of reactions leading to structural changes. Based on the historical data for the prices of Ottoman government bonds, we argue that large fluctuations in bond prices can provide information on how bondholders in the Ottoman Empire reacted to unanticipated events. Our empirical findings identify five break points that corresponded to events about the Turco-Italian war and the First Balkan war. Bond prices began to fall considerably on 21 September 1911 as there was a significant increase in variances. The break point occurred one week before the war between the Ottoman Empire and Italy started. The bond price experienced another large fall on 29 September 1911 when the war began. There were two other break points observed on 17 November 1911 and 29 February 1912 related to events in the Turco-Italian war. Another break is identified on 29 September 1912, just before the end of the Turco-Italian war and prior to the outbreak of the First Balkan war. News and commentary in the Ottoman newspapers often included negative messages, reflecting that war would be possible in the near future. For investors, that meant higher default risk, which led to lower prices for government bonds due to capital outflows, as volatility increased. During wars in our sample, the Ottoman Empire experienced an increasing debt burden due to military expenditures. The Ottoman state began to borrow at high rates during these times. The interest rate for long-term borrowing increased from 4 percent in 1911 to 5 percent in 1914 (Kıray, 1995: pp. 213e21). These rate _ increases indicate why bondholders at the Istanbul bourse considered war as a source of risk, reflected by decreasing _ prices. Accordingly, it can be argued that the Istanbul bourse was sensitive to the political crises of 1910e1914, in contrast to Ferguson's (2006) study on the London bourse. This could be related to the fact that the political crises heralded the onset of WWI, the decline of the Ottoman Empire, and many economic problems such as inflation, and a decrease in trade and _ production. It seems that the price changes on the Istanbul bourse were informative for the Ottoman politicians, whom the war caught unaware, allowing them to successfully anticipate the economic results of war. This paper could lead to further research if detailed data on the number of bonds in circulation, volume of trade, and investor profiles in the Ottoman Empire were to be found, as _ this information would help to characterize the Istanbul bourse. References _ Akyıldız, A. (2001). Osmanlı D€onemi Tahvil ve Hisse Senetleri. Istanbul: Tu¨rk Ekonomi Bankası. Bai, J., & Perron, P. (1998). Estimating and testing linear models with multiple structural changes. Econometrica, 66(1), 47e78. Bai, J., & Perron, P. (2003). Computation and analysis of multiple structural change models. Journal of Applied Econometrics, 18(1), 1e12. Basdas, U., & Oran, A. (2014). Event studies in Turkey. Borsa Istanbul Review, 14(3), 167e188.
€ et al., War-related risks and the Istanbul _ _ Please cite this article in press as: Hanedar, A. O., bourse on the eve of the First World War, Borsa Istanbul Review (2015), http://dx.doi.org/10.1016/j.bir.2015.05.001
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€ et al., War-related risks and the Istanbul _ _ Please cite this article in press as: Hanedar, A. O., bourse on the eve of the First World War, Borsa Istanbul Review (2015), http://dx.doi.org/10.1016/j.bir.2015.05.001