‘Prolonged uncertainty’ of Brexit sent waves of financial volatility across Europe, research finds

New research has revealed that the political and economic chaos created in Britain by the vote to leave the European Union in 2016 was not only limited to causing problems at home, but also created “fiscal shockwaves” across Europe.

Trade barriers and labor shortages, which have caused long-term damage to the UK economy and a decline in per capita income after leaving the EU, have brought years of political turmoil, with six prime ministers taking office since the referendum was called a decade ago.

But the effects of the post-Brexit voting chaos also served to reveal how tight financial ties can be across the developed world, and what might happen when those bonds are tested.

Researchers at the University of Surrey analyzed more than two decades of stock market data across the EU and found that Brexit-related events “significantly increased the volatility spread across European markets.”

The researchers noted that turmoil over Brexit and the Conservative government’s handling of a process that saw political announcements, negotiations and repeated leadership changes as the country sought to sever ties with the EU “repeatedly triggered fiscal reactions that spread across the EU and markets.”

At one point in 2017, the inconsistency of the UK’s stance led EU diplomats to suggest that the rifts, contradictions and confusion in the Cabinet were too ridiculous to be true and must be part of an elaborate bluff to convince EU negotiators that the UK had no plan.

This political chaos spread mainly through uncertainty in major markets, which in turn spread shocks to smaller markets that were then felt acutely.

Rather than being a single economic shock, Brexit functions as a “prolonged sequence of uncertainty”, researchers said.

“Each political milestone, from the referendum result to parliamentary votes and trade negotiations, has shifted investor expectations and sent signals through financial markets across Europe,” they said.

The analysis highlights that larger financial markets such as Paris and London tend to transmit volatility to smaller ones: “France has emerged as the most persistent transmitter of volatility across the EU in the Brexit period, while the UK acted as a significant transmitter in the early stages of negotiations,” they said.

However, those most affected by the turbulence were smaller markets operating in countries such as Ireland, Portugal and Spain.

To understand and quantify how political and economic shocks ripple through Britain, the Surrey team examined more than two decades of daily market data from EU countries from 2000 to 2021.

They then designed a new “Brexit intensity” index that tracks nearly 500 political and economic events throughout the Brexit process and combined this with “volatility modelling.”

Each event was weighted according to how strongly financial markets reacted using indicators such as stock returns, exchange rate movements and other measures of market volatility.

Lead author of the study and associate professor of accounting and finance at the University of Surrey, Dr. “Brexit was a long series of political shocks that financial markets in the UK and across the continent had to confront in real time,” said Vasileios Pappas.

“What we have shown is that every major announcement or political change sends signals through European markets, spreading uncertainty well beyond the UK,” he added.

But as volatile political events increased in frequency, the team said they were seeing changes in the markets’ reaction, most strikingly Brexit weakening financial integration in Europe.

They said that after Brexit, the level of volatility transmission between EU markets fell sharply, indicating that markets began to react more independently in an environment of increasing political uncertainty.

Dr Pappas added: “Financial markets are closely linked across borders. Once uncertainty increases in a country, it rarely stays there. By understanding how these shocks propagate, we can better predict risks and strengthen financial stability.”

The research was published at: International Journal of Finance and Economics.