The interplay between banks and markets: supervisory stress test results and investor reactions

This chapter provides an overview of European bank stress tests, one of the supervisory tools used to provide investors with in-depth information on the risks and profit drivers of big lenders. The authors review previous evidence on stress test exercises run by the Federal Reserve and by European supervisors (including the European Banking Authority and the European Central Bank), discussing the key differences in stress test programmes across the two areas in terms of institutional designs, scenario assumptions and disclosure procedures. The interplay between banks and markets is analysed by looking at investor reactions upon the announcement of stress test results. The chapter also includes some brief concluding remarks on the functions of the stress tests.