The Impact of Credit Protection on Stock Prices in the Presence of Credit Crunches

28 Pages Posted: 21 Jul 2009 Last revised: 17 May 2023

See all articles by Galina Hale

Galina Hale

University of California, Santa Cruz

Assaf Razin

Tel Aviv University - Eitan Berglas School of Economics; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Hui Tong

International Monetary Fund (IMF)

Date Written: July 2009

Abstract

Data show that better creditor protection is correlated across countries with lower average stock market volatility. Moreover, countries with better creditor protection seem to have suffered lower decline in their stock market indexes during the current financial crisis. To explain this regularity, we use a Tobin q model of investment and show that stronger creditor protection increases the expected level and lowers the variance of stock prices in the presence of credit crunches. There are two main channels through which creditor protection enhances the performance of the stock market: (1) The credit-constrained stock price increases with better protection of creditors; (2) The probability of a credit crunch leading to a binding credit constraint falls with strong protection of creditors. These mechanisms are consistent with the patterns observed in the cross-country data. We find that except for OECD countries with low creditor protection, stock market return is negative in the crisis years and positive in non-crisis years.

Suggested Citation

Hale, Galina and Razin, Assaf and Tong, Hui, The Impact of Credit Protection on Stock Prices in the Presence of Credit Crunches (July 2009). NBER Working Paper No. w15141, Available at SSRN: https://ssrn.com/abstract=1434655

Galina Hale

University of California, Santa Cruz ( email )

1156 High St
Santa Cruz, CA 95064
United States

Assaf Razin (Contact Author)

Tel Aviv University - Eitan Berglas School of Economics ( email )

P.O. Box 39040
Ramat Aviv, Tel Aviv, 69978
Israel
+972 3 640 7303 (Phone)
+972 3 640 9908 (Fax)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Hui Tong

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States