Decoding market reactions: The certification role of EU-wide stress tests

Abstract

We study the market’s reaction to the disclosure of EU-wide stress test results across four periods (2014, 2016, 2018, and 2021). Our novel approach contributes to the literature by studying how stress test disclosures influence both the mean and variance (first and second moments) of bank stock performance, extending beyond previous studies focused mainly on the first moment of equity returns. Using one-factor market and structural Engle–Siriwardane type GARCH models, we find that the publication of stress tests provides new information to the markets: Banks with weaker performance in the tests experience, on average, a reduction in stock returns and an increase in volatility, while the reverse holds for banks performing well. Our findings confirm the important role of stress tests in enhancing transparency and market discipline, thereby supporting investors in assessing the resilience of the banking sector more effectively, particularly during periods of higher uncertainty.