The Impact of Creditor Protection on Stock Prices in the Presence of Liquidity Crises: Theory and Cross-Country Evidence

32 Pages Posted: 4 Apr 2012

See all articles by Galina Hale

Galina Hale

Federal Reserve Bank of San Francisco

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: March 30, 2012

Abstract

We develop a model predicting two channels through which creditor protection enhances the performance of stock prices: the probability of a liquidity crisis leading to a binding investment-finance constraint falls with a strong protection of creditors; the stock prices under the investment-constrained regime increase with better protection of creditors. We find 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 1980-2008. In particular, we find that better creditor protection is correlated across countries with lower average stock market volatility, crises are more frequent in countries with poor creditor protection. Using propensity score matching we also show that during crises stock market returns and investment 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 Liquidity Crises: Theory and Cross-Country Evidence (March 30, 2012). CESifo Working Paper Series No. 3765. Available at SSRN: https://ssrn.com/abstract=2034212

Galina Hale

Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States
415-974-3131 (Phone)
415-974-2168 (Fax)

HOME PAGE: http://www.frbsf.org/economic-research/economists/galina-hale/

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

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