Do Stress Tests still have a significant effect on the market? Evidence from the 2018, 2019 and 2021 stress test

The objective of this article is to analyze the market reaction to stress tests conducted in the United States and the European Union from 2018 to 2021 using an event study approach. We observe that, in general, US stress tests have a positive impact on the stock value of stressed banks, while we do not find any impact of EU stress test. The only exception in the EU is for the 2021 stress test where we find a negative impact on the market. To interpret these results, we further study the governance of the stress tests. We find that European banking regulations are at the point of criticism for being less credible. This lower credibility comes from a lack of coordination in the scenarios and the manipulation of the results by states to avoid being seen as weak – made possible due to the bottom-up approach used for European exercises. We claim that these are the reasons why we do not find any significant results for the EU exercises. On the contrary, we observed that US banking authorities use a top-down approach and have improved their regulatory measures, such as increasing the level of information disclosure. Again, we claim that these characteristics drive the market response to U.S. stress tests. Finally, we conclude that the qualitative aspects of stress test governance can still influence the market in more recent stress tests.