Institutional Weakness and Stock Price Volatility
28 Pages Posted: 15 May 2006 Last revised: 20 Feb 2022
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Institutional Weakness and Stock Price Volatility
Institutional Weakness and Stock Price Volatility
Date Written: March 2006
Abstract
We find an empirical regularity that stronger creditor protection reduces the volatility of stock market prices. We analyze two distinct mechanisms that characterize equity price volatility: government guarantees and creditor protection. Using a Tobin q model, we demonstrate that weak creditor protection that gives rise to government guarantees and tightens credit constraints, increases stock price volatility. Empirically, accounting for the probability of financial crises, we find that government guarantees and weak institutions that tighten credit constraints increase aggregated stock price volatility.
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