Navigating through Economic storms - A comparative analysis of stock market responses to recent European recessions

Abstract: The study investigates the interplay between stock market behaviour and recessions in the Northern and Western European area, focusing on data from three different recessions in five countries since 1986. First, unadjusted stock prices show some predictive power in anticipating financial crises, while time-aggregated stock prices do not. During the Covid-19 pandemic, the economic downturn could not be anticipated by the stock market, and investors were over-optimistic. Second, stock price changes exhibit an increase in volatility during recessions, contrasting with the relative stability of dividends. This implies heightened uncertainty and risk-aversion among investors in episodes of economic downturn. Third, standard asset pricing theories alone struggle to fully explain stock market behaviour during recessions. The study suggests that short-term policy changes have a great impact on investor behaviour during pandemics specifically.