The Corona Crisis as Ultimate Stress Test- Market Reaction to EBA´s 2020 Stress Test Postponement

Abstract: In response to the COVID-19 outbreak, the European Banking Authority (EBA) decided to postpone its biennial 2020 stress test to 2021. The supervisory exercise was supposed to answer whether banks have sufficient capital to withstand the impact of a global economic recession. This paper investigates the stock market response to EBA´s stress test postponement and various related key events. For this purpose, the thesis employs both a standard event study and cross-sectional regressions. Overall, the market seemed to appreciate EBA´s stress test-related disclosures, as measured by significant abnormal returns around defined key events. Whereas the market approached the launch of the 2020 stress test with a prevalent positive sentiment, the trend reverted as the pandemic aggravated. In addition, the analysis of stress tested versus non-tested banks indicates that investors´ focus shifted from idiosyncratic to aggregate systemic risk for assessing the banking industry´s resilience in crisis times. Absolute abnormal returns revealed a significant cross-sectional variation for the postponement event. The regression´s results provide evidence that latter findings can be attributed to market participants updating their a priori beliefs in relation to expected stress test outcomes.