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

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  • Hale, Galina B
  • Razin, Assaf
  • Tong, Hui

Abstract

Data show that better creditor protection is correlated across countries with lower average stock market volatility. Moreover, countries with better creditor protection are observed to have suffered lower decline in their stock market indexes during the current financial crisis. To explain this regularity, we use a stylised Tobin-q model of investment. Our model predicts that (1) the incidence of credit crunches should be lower in countries with better creditor protection; and, {2) that the decline in the stock market index during crises should be lower in countries with better creditor protection. We find support for these mechanisms in a panel data consisting of both OECD and OECD countries. We find that countries with higher level of creditor-rights protection are less likely to experience liquidity crises, even within the subsamples of OECD and non-OECD countries. We find, however, that only in the subsample of non-OECD countries do we observe a larger decline in the stock market index for countries with low level of creditor rights protection, in the presence of credit crunches.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7357.

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Date of creation: Jul 2009
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Handle: RePEc:cpr:ceprdp:7357

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Keywords: credit crunch; Tobin Q;

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  1. Hart, O. & Moore, J., 1991. "A Theory of Debt Based on the Inalienability of Human Capital," Working papers 592, Massachusetts Institute of Technology (MIT), Department of Economics.
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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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