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

29 Pages Posted: 19 May 2011

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)

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Date Written: April 29, 2011

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: the credit-constrained stock price increases with better protection of creditors and the probability of a credit crunch leading to a binding credit constraint falls with strong protection of creditors. We find strong empirical support for both predictions using data on stock market performance, amount and cost of credit, and creditor rights protection for 52 countries over the period 1980-2007. In particular, we find that crises are more frequent in countries with poor creditor protection. Using propensity score matching we also show that during crises stock market returns fall by more in countries with poor creditor protection.

Keywords: liquidity crisis, creditor protection, stock volatility, credit crunch

JEL Classification: E440

Suggested Citation

Hale, Galina and Razin, Assaf and Tong, Hui, The Impact of Creditor Protection on Stock Prices in the Presence of Credit Crunches (April 29, 2011). CESifo Working Paper Series, No. 3440, Available at SSRN: https://ssrn.com/abstract=1837313 or http://dx.doi.org/10.2139/ssrn.1837313

Galina Hale

University of California, Santa Cruz ( email )

1156 High St
Santa Cruz, CA 95064
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Assaf Razin (Contact Author)

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

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Israel
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+972 3 640 9908 (Fax)

National Bureau of Economic Research (NBER) ( email )

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CESifo (Center for Economic Studies and Ifo Institute)

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Centre for Economic Policy Research (CEPR)

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United Kingdom

Hui Tong

International Monetary Fund (IMF) ( email )

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

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