Investor Protection and Asset Prices

Abstract:     

There is substantial empirical evidence that investor protection affects stock returns, volatilities and interest rates. We develop a dynamic asset pricing model to shed light on the empirical regularities and underlying mechanisms at play. Our model features a controlling shareholder who can divert a fraction of the firm's output. The controlling shareholder's power over the firm is endogenous and interacts with investor protection in determining the level of expropriation. In equilibrium, imperfect investor protection implies higher stock holdings by controlling shareholders, lower stock returns, higher stock return volatilities and lower interest rates.

Number of Pages in PDF File: 36

Keywords: investor protection, asset pricing, controlling shareholders, expropriation, stock holdings

JEL Classification: G12, G32