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The impact of creditor protection on stock prices in the presence of credit crunches

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  • Galina Hale
  • Assaf Razin
  • Hui Tong

Abstract

A Tobin q model of investment is used to 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. ; The paper tests the predictions of the model by using cross–country panel regressions of stock market returns in 40 countries over the period from 1984 to 2004 at an annual frequency. We find broad empirical support for the prediction of the model that creditor protection increases the expected level of the stock market price level and reduces its volatility, both directly and indirectly, by lowering the probability of credit crunches.

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Article provided by Federal Reserve Bank of San Francisco in its journal Proceedings.

Volume (Year): (2009)
Issue (Month): Jan ()
Pages:

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Handle: RePEc:fip:fedfpr:y:2009:i:jan:x:6

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  1. John D. Burger & Francis E. Warnock, 2004. "Foreign participation in local-currency bond markets," International Finance Discussion Papers 794, Board of Governors of the Federal Reserve System (U.S.).
  2. John D. Burger & Francis E. Warnock, 2006. "Local Currency Bond Markets," IMF Staff Papers, Palgrave Macmillan, vol. 53(si), pages 7.
  3. Hale, Galina B & Razin, Assaf & Tong, Hui, 2006. "Institutional Weakness and Stock Price Volatility," CEPR Discussion Papers 5651, C.E.P.R. Discussion Papers.
  4. Oliver Hart & John Moore, 1991. "A Theory of Debt Based on the Inalienability of Human Capital," NBER Working Papers 3906, National Bureau of Economic Research, Inc.
  5. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  6. James J. Heckman, 1977. "Dummy Endogenous Variables in a Simultaneous Equation System," NBER Working Papers 0177, National Bureau of Economic Research, Inc.
  7. Guillermo A. Calvo & Alejandro Izquierdo & Ernesto Talvi, 2006. "Phoenix Miracles in Emerging Markets: Recovering without Credit from Systemic Financial Crises," NBER Working Papers 12101, National Bureau of Economic Research, Inc.
  8. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
  9. Dmitry Livdan & Horacio Sapriza & Lu Zhang, 2006. "Financially Constrained Stock Returns," NBER Working Papers 12555, National Bureau of Economic Research, Inc.
  10. Arturo Galindo & Alejandro Micco, 2005. "Creditor Protection and Credit Volatility," Research Department Publications 4401, Inter-American Development Bank, Research Department.
  11. Sassan Alizadeh & Michael W. Brandt & Francis X. Diebold, 2001. "High- and Low-Frequency Exchange Rate Volatility Dynamics: Range-Based Estimation of Stochastic Volatility Models," NBER Working Papers 8162, National Bureau of Economic Research, Inc.
  12. Reuven Glick & Ramon Moreno & Mark Spiegel, 2001. "Financial crises in emerging markets," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue mar.23.
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Cited by:
  1. World Bank, 2012. "Resilience, Equity, and Opportunity," World Bank Other Operational Studies 12648, The World Bank.

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