The Impact of IFRS Adoption

on Stock Market Volatility

Pushpa Negi*, Romit Raja Srivastava** and Shiva Bhasin***
From 2005 onwards, consolidated financial statements of listed European companies of around 7,000 had to comply
with IFRS (IAS). This study examines the impact of IFRS adoption on the stock market volatility of 10 European stock
markets by fitting Autoregressive Conditional Heteroskedasticity (ARCH) and Generalized Autoregressive Conditional
Heteroskedasticity (GARCH) models. The data was obtained from yahoofinance.com for the period January 1, 2005
to December 31, 2005. The stationarity of the time series was checked through unit root test and then descriptive
statistics of different stock indices was obtained. The ARCH model was applied to check the presence of ARCH effect
in all return series and GARCH(1, 1) model was used to estimate the return volatility. The results suggested that
there was high volatility of returns in the markets during the sample period. The GARCH coefficient of Austria,
France, Germany, Hungary, Spain and the United Kingdom was close to 1, which indicates that volatility shocks were
quite persistent. The coefficient of the lagged squared returns was also positive for these indices, and it implied that
stock market volatility or market operators react more to good news than bad news, or the market is positive about the
adoption of IFRS. On the other side, the IFRS adoption news did not affect the volatility of Greece, Italy, the
Netherlands and Portugal during the sample period.

Introduction
The aim of International Financial Reporting Standards (IFRS) is to provide a general direction
for the preparation of financial statements and not to set the rules for industry-specific
reporting. IFRS adoption increases the process of harmonization of accounting standards
worldwide. Substantial works have been done not only by the European Union (EU) but also
by the International Accounting Standards Board (IASB) since the 1970s to harmonize
accounting rules in different countries. The purpose was only to improve the usefulness of
financial information in the international context. According to the American Institute of
Certified Public Accountant (AICPA), a business can present its financial statements on
the same basis as its foreign competitors, making comparisons easier by adopting IFRS. Besides,
companies with subsidiaries in countries that require or permit IFRS may be able to prepare
accounts by one method. A subsidiary of a foreign company may also need to convert its
accounts by IFRS or if they have a foreign investor that must use IFRS. Companies may also
benefit by using IFRS if they wish to raise capital abroad. Hail et al. (2009) described that one
*

Assistant Professor, Symbiosis Law School (SLS), Symbiosis International University (SIU), Opposite Nokia
Siemens Building, Block A 47/48, Sector-62, Noida 201301, Uttar Pradesh, India.
E-mail: pushpa@symlaw.edu.in

**

Student, Symbiosis Law School (SLS), Symbiosis International University (SIU), Opposite Nokia Siemens
Building, Block A 47/48, Sector-62, Noida 201301, Uttar Pradesh, India. E-mail: romitrajasrivastava@msn.com

*** Student, Symbiosis Law School (SLS), Symbiosis International University (SIU), Opposite Nokia Siemens
Building, Block A 47/48, Sector-62, Noida 201301, Uttar Pradesh, India. E-mail: shivabhasin@gmail.com
2014 IUP. All Rights Reserved.
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The IUP Journal of Applied Finance, Vol. 20, No. 4, 2014

of the benefits of moving to IFRS is that it can enhance the liquidity of capital markets and
reduce companies costs of capital by providing investors with better information on corporate
performance. The benefit to investors could also lead to more-informed valuation of equity
markets, reducing the risk of adverse selection for the less-informed investors.
Alternatively, there is a big disadvantage about companies in Europe adopting IFRS, like
the current and future accountants had to relearn how to do their jobs. Though it does not
seem to be a problem, it is something to be considered because the accountants are still
learning how to prepare financial statements under IFRS. One more fact is that IFRS
necessitates application of fair value principles in certain situations. This would result in
significant differences from financial information that are currently presented, especially
relating to financial instruments and business combinations. This could have resulted in
significant volatility in reported earnings and key performance measures like EPS and P/E
ratios. This instability in reported earnings can lead to volatility in the returns of a stock
market of a country. On the other side, all the benefits rely on the presumption that mandatory
IFRS adoption provides superior information to market participants compared to previous
accounting regimes, and this can affect the stock market positively.
This paper aims at examining the impact of IFRS adoption on the stock market volatility
of 10 European markets by fitting Autoregressive Conditional Heteroskedasticity (ARCH)
and Generalized Autoregressive Conditional Heteroskedasticity (GARCH) models
introduced by Engle (1982), Bollerslev (1986) and Nelson (1991). As volatility is one of the
most important concepts in finance, it refers to the degree of fluctuations or the variability of
a variable around its mean, where mean may be constant or varying with time or other
variables. Standard deviation or variance of series is used to measure the volatility and is
often used as a crude measure of the total risk of financial assets.

Literature Review
The objective of IFRS is to provide a global framework so that public companies can prepare
and disclose their financial statements. Beuselinck et al. (2009) reported that the main
objective of IFRS adoption is to clarify the core principles, ensure the consistency of accounting
principles and make the accounting standards easier to understand and apply. There should
be uniformity and a common set of standards which will lead to transparency in financial
data disclosure. Spauwen (2009) found that the implementation of IFRS is not only about
different accounting standards and policies, but also leads to performance measurement and
communication with the markets. Iatridis (2010) reported that the adoption of IFRS will
bring fair values, which might bring volatility in assets and liabilities and would also reduce
information asymmetry. The implementation of IFRS reduces cost transactions and helps
investors in investing internationally. This will also enhance stock market efficiency and
will leave a positive impact on firms stock returns.
Soderstrom and Sun (2009) reported that there is a positive impact following the voluntary
adoption of IFRS. Negash (2008) described that IFRS is very useful (than IAS and national
The Impact of IFRS Adoption on Stock Market Volatility

59

GAAPs) in providing enhanced information by which investors (savers) and their agents
(analysts) get price signals that reflect maintainable earnings with minimum errors in selecting
the market. Platikanova (2009) stated that IFRS was introduced to increase the accounting
quality and ensure greater comparability and transparency of financial reporting around the
world. Bruggemann et al. (2009) explored that adoption of IFRS enhances the comparability
of financial statements across countries and it would strengthen foreign equity investments.
Or, we can say that it can remove cross-border entry barriers by replacing country-specific
accounting rules with one single set of standards. Ramanna and Sletten (2009) examined
variations in the decision to adopt IFRS. Network theory can be considered as a tool to
explain the inter-temporal increase in the adoption of IFRS across countries.
The study of Paananen and Parmar (2008) testified to the effect of IFRS adoption in UK.
The results showed that despite the fact that US GAAP, IFRS and UK GAAP are all marketoriented sets of accounting standards, both FASB and IASB tend more to require fair value
accounting with regard to assets and liabilities compared to UK GAAP. Brochet et al. (2011)
reported the effect of mandatory IFRS adoption on financial statements comparability. The
effect of mandatory IFRS adoption is too inconsistent for comparing the financial statements.
Daske et al. (2008) studied the economic consequences of mandatory IFRS reporting around
the world. There was a drastic change in the stock market after the adoption of IFRS.
Armstrong et al. (2008) examined the market reaction to the adoption of IFRS in Europe.
The adoption of IFRS had led to change in the liquidity costs of the companies in European
nations. The studies of Ciesielski (2007), Ding (2007), and Norris (2007) reported that along
with the country-level power politics, the perception of IFRS as a European institution is
likely to affect the international standards acceptance in a country. India is considered as
one of the key global players, and adoption of IFRS could enable Indian companies to have
access to international capital markets. Also, it facilitates companies to set targets and
milestones based on the global environment. The IFRS-converged accounting standards
deal with mark-to-market projections and valuation of financial assets, among other things.
A number of studies have investigated accounting convergence process in several countries
(Haller and Eierle, 2004; Sucher and Jindrichovska, 2004; Vellam, 2004; Delvaille et al. 2005;
and Guerreiro et al., 2008). No study has been done on the stock market volatility due to the
adoption of IFRS. This paper, therefore, aims to fill this gap.

Data and Methodology

To find out the impact of IFRS adoption on the stock market volatility, 10 countries of the
European Union (EU)Austria, France, Germany, Greece, Hungary, Italy, the Netherlands,
Portugal, Spain, and the United Kingdomhave been considered for the study.
The dataset consists of the daily returns of the stock indices of these ten countries: WBI
of Austria; SBF of France; DAX of Germany; ATHEX20 of Greece; BUX of Hungary; FTSEMIB
of Italy; AEX of the Netherlands; PSI20 of Portugal; IBEX35 of Spain and FTSE100 of the
United Kingdom. Days when there is no trading are not taken and the price change is
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The IUP Journal of Applied Finance, Vol. 20, No. 4, 2014

calculated from the last day the market was open. The stock prices were collected from
yahoofinance.com for the period January 1, 2005 to December 31, 2005. Only stocks for
which data was available for the one year sample period, were selected. The data is plotted in
levels (P) and returns (R) in Figures 1 and 2, respectively. Figure 1 shows the fluctuation of
the returns and confirms the volatility clustering fact. Financial time series observations of
this type have led to the use of GARCH models in financial forecasting and derivatives
pricing. The returns are calculated by the log difference change in the price index Rt = logPt
logPt 1, where Rt = return at time t and Pt, Pt1 = closing value of the stock price index.
Figure 1: Stock Returns
40,000
35,000
30,000

Price

25,000
20,000
15,000
10,000
5,000
0

25

50

75

100

125 150 175 200 225 250

Time (Days)
WBI

SBF

DAX

ATHEX

BUX

FTSEMIB

AEX

PSI

IBEX

FTSE

Results and Discussion

Descriptive Statistics
Diagnostic statistical tests were undertaken to check the characteristics of the data before
modeling the stock market return and its volatility. The summary of descriptive statistics is
shown in Table 1. The statistics show that the average daily return rate of all the markets was
between 0.000578 and 0.001569. The standard deviation in returns, which is indicative of
the unconditional variance in returns, however continues to remain almost the same in all
series, except BUX. The negative (positive) value for skewness indicates that the series
distribution is skewed to the left (right). The kurtosis of the WBI and PSI return rate are
about 5.058837 and 9.789352, respectively, which means it is leptokurtic, a phenomenon
The Impact of IFRS Adoption on Stock Market Volatility

61

Figure 2: Volatility Clustering

0.06
0.04

Returns

0.02
0.00
0.02
0.04
0.06

25

50

75

100

125

150

175

200

225

250

Time (Days)
FTSE100

IBEX35

PS120

AEX

FTSEMIB

BUX

ATHEX20

DAX

SBF

WBI

Table 1: Descriptive Statistics for Stock Returns of Different Indices

Index

Mean

SD
(%)

Skewness

Excess
Kurtosis

JB

WBI

0.001569

0.007490

0.584673

5.058837

SBF

0.000985

0.007074

0.136495

3.795835

7.255739

0.0000

DAX

0.001361

0.009088

0.103981

3.454392

2.559638

0.0003

ATHEX

0.001361

0.009088

0.009088

3.454932

2.559638

0.0000

BUX

0.001115

0.014528

0.211861

3.722824

7.195650

0.0011

FTSEMIB

0.000659

0.006956

0.583701

4.247020

AEX

0.000928

0.006803

0.293770

3.756863

PSI

0.000963

0.005980

1.009398

9.789352

IBEX

0.000984

0.006416

0.237444

3.439097

4.287830

0.0000

FTSE

0.000578

0.005543

0.194897

3.717898

6.840007

0.0002

57.46336

29.90834
9.409957
514.2511

ADF
(Level)
0.0000

0.0183
0.0000
0.0000

which has been widely documented in the literature of stock market returns, and according
to Adrangi et al. (1999), this kurtosis has a fat tail. The Jarque-Bera (JB) test rejects normality
at 5% level for all distributions. To check whether sample data has the skewness and kurtosis
matching a normal distribution, the JB test is a goodness of fit test. Moreover, all log-prices
are non-stationary [I(1)], while all returns are stationary [I(0)].
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The IUP Journal of Applied Finance, Vol. 20, No. 4, 2014

ARCH(m) Model
ARCH/GARCH model, first introduced by Engle (1982), Bollerslev (1986) and Nelson
(1991), is applied in this study to test the hypothesis that the European markets return rate
volatility is highly persistent or not and also to check the presence of ARCH effect in errors.
In a more formal way, we can present the model of stock returns as follows:
R c R t 1 t

t zt . ht
where zt~N (0, 1)

h t 1 t21 2 t22 ... m t m

The first line of this model is the mean equation, which shows that returns follow an
AR(1) process. We can introduce any suitable specification of mean return by changing this
line. The second and third lines jointly constitute the variance equation. The mean and
variance equations are jointly estimated using ML estimator.
Table 2 reports the results of ARCH tests,
indicating that ARCH effect exists up to the
lagged order 28 in the log return series. Tests
of ARCH in returns show strong evidence of
presence of ARCH in all the return series.
We, therefore, use the Generalized ARCH
(GARCH) model suggested by Bollerslev
(1986) to analyze volatility in the return
series.

GARCH Model

Table 2: Results of ARCH Test

Index

P-Value

WBI

0.0000

SBF

0.0000

DAX

0.0000

ATHEX

0.0000

BUX

0.0001

FTSEMIB

0.0000

AEX
0.0000
The most popular among the models of
conditional volatility is the Generalized
PSI
0.0000
ARCH or the GARCH(r, m) model. This
IBEX
0.0000
model is same as infinitive order ARCH
FTSE
0.0001
model (that is why, it gets its name the
generalized ARCH model). In GARCH(r, m) model the conditional volatility (ht) is the
function of past conditional volatility (ht r) and past squared innovations in mean equation
( 2t m). The GARCH(1, 1) model is more popular in practice. This model for the stock
returns can be presented as follows:

R c R t 1 t

t zt . ht
where zt~N (0, 1)

h t t21 h t 1
The Impact of IFRS Adoption on Stock Market Volatility

63

The unconditional (average) variance from this model is:

where ( + ) measures the persistence of volatility. This is usually observed to be very close
to 1, which signifies that the volatility of asset returns is highly persistent in practice. The
effect of any shock in volatility dies out at a rate of (1 ). If ( + )1, the effect of
shock will never die out. Since the variance cannot be negative, the other parameter restriction
which is imposed while estimating a GARCH model is the non-negativity of , and
coefficients.
We examined the conditional mean structure by estimating GARCH process under the
GARCH(1, 1) models. The result from mean equation, while including the data from January
1 to December 31, 2005 for all the indices, shows the significant value of and . The results
of all the indices are summarized in Table 3.
Table 3: Results of GARCH(1, 1) Model
Index

AIC

WBI

0.963758

0.013893

0.977615

0.0001

SBF

0.054564

0.859250

0.913814

0.0000

DAX

0.058193

0.876607

0.9348

0.0000

ATHEX

0.031157

0.515833

0.54699

0.5494

BUX

0.050382

0.885460

0.935842

0.0000

FTSEMIB

0.102782

0.185374

0.288156

0.6056

AEX

0.087573

0.041151

0.128724

0.9448

PSI

0.060979

0.412922

0.473901

0.3756

IBEX

0.426700

0.523705

0.950405

0.0000

FTSE

0.0858187

0.893460

0.9792787

0.0000

From Figure 2, it can be seen that the return series clearly shows volatility clustering for the
entire European index. Mandelbrot (1963) stated that large changes have a tendency to be
followed by large changes, and small changes have a tendency to be followed by small changes.
Rama (2005) explained that a quantitative manifestation of this fact is that while returns
themselves are uncorrelated, absolute returns or their squares display a positive, significant and
slowly decaying autocorrelation function. GARCH models (Bollerslev et al., 1992; and Engle,
1995) were the first models to take into account the volatility clustering phenomenon. In a
GARCH(1, 1) model, the (squared) volatility depends on last periods volatility.
From Table 3, it is observed that the GARCH coefficients ( + ) of Austria (WBI),
France (SBF), Germany (DAX), Hungary (BUX), Spain (IBEX) and United Kingdom (FTSE)
are close to 1, indicating that the volatility shocks are quite persistent. This result is often
observed in high frequency data. The coefficient of the lagged squared returns is also positive
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The IUP Journal of Applied Finance, Vol. 20, No. 4, 2014

for these indices and statistically significant at 1% level. The positive coefficient of the
asymmetric effect implies that stock market volatility or market operators react more to good
news than bad news or the market is positive about the adoption of IFRS. So, we can conclude
that in the case of Austria, France, Germany, Hungary, Spain and the United Kingdom,
strong GARCH effects are apparent. On the basis of these results, it is evident that there is
significant time-varying volatility in return series during the sample period and the IFRS
adoption news affected the stock market volatility of these countries. However, there are
many other factors that might contribute to the volatility of stock prices such as the choice
of monetary policy and the exchange rate regime, central bank independence, levels of output,
income, inflation, and uncertainty within the political scene.
On the other side, the IFRS adoption news did not affect the volatility of Greece (ATHEX),
Italy (FTSEMIB), the Netherlands (AEX) and Portugal (PSI) during the sample period. The
reason might be that Greek companies listed in the Athens Stock Exchange were required to
apply IFRS from the calendar year 2003. Later, Greece tried to resolve the problems that
might have emerged due to the haste with which it introduced the obligatory IFRS in 2003.
Therefore, publicly traded companies of Greece were required to report under IFRS by 2005.
The Netherlands is also an EU Member State. Subsequently, Dutch companies listed in an
EU/EEA securities market have been following IFRS since 2005. But the result of the study
showed that there is no effect of IFRS adoption on the stock market of the Netherlands, Italy
and Portugal. Daske et al. (2007) conveyed that the benefits from implementing IFRS for
capital market exist only in countries with strict enforcement regimes and institutional
environment that provide strong reporting incentives.

Conclusion
IFRS adoption by European countries signified a major milestone towards financial reporting
convergence, yet encouraged controversy that reached the highest levels of government. EU
companies which are listed were required to prepare their consolidated financial statements
in accordance with IFRS for years beginning on or after January 1, 2005. This paper has
examined the volatility of returns in 10 European financial markets due to IFRS adoption by
applying ARCH and GARCH models. The stationarity of the time series was checked through
unit root test, and descriptive statistics was obtained to report mean, standard deviation,
skewness, and kurtosis of the time series of different stock indices. The results suggest that
there was generally high volatility of returns in the markets during the sample period. It was
observed that the GARCH coefficients of Austria, France, Germany, Hungary, Spain and the
United Kingdom was close to 1, indicating that volatility shocks were quite persistent. The
coefficient of the lagged squared returns was also positive for these indices, and it implied
that stock market volatility or market operators react more to good news than bad news, or
the market is positive about the adoption of IFRS. On the other side, the IFRS adoption news
did not affect the volatility of Greece, Italy, the Netherlands and Portugal during the sample
period.
The Impact of IFRS Adoption on Stock Market Volatility

65

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