The Certification Role of the EU-Wide Stress Testing Exercises in the Stock Market. What Can We Learn from the Stress Tests (2014-2021)?

What is the impact of stress tests on bank stock prices? To answer this question we study the impact of the publication of the EU-wide stress tests in 2014, 2016, 2018, and 2021 on the first and second moment of equity returns. First, the effect of the disclosure of stress tests on (cumulative) excess/abnormal returns is studied through a one-factor market model. Second, both returns and volatility of bank stock prices changes upon the disclosure of stress tests are investigated through a structural GARCH model. Results suggest that the publication of stress tests provides new information to markets. Banks performing poorly in stress tests experience, on average, a reduction in returns and an increase in volatility, while the reverse holds true for banks performing well. Banks performing moderately have rather a small effect on both mean and variance process. These results indicate that the publication of stress tests improves price discrimination between ’good’ and ’bad’ banks, which can be interpreted as a certification role of the stress tests in the stock market