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

Author

Listed:
  • Galina Hale
  • Assaf Razin
  • Hui Tong

Abstract

We develop a model predicting two channels through which creditor protection enhances the performance of stock prices: (1) The probability of a liquidity crisis leading to a binding investment-finance constraint falls with a strong protection of creditors; (1) 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.

Suggested Citation

  • Galina Hale & Assaf Razin & Hui Tong, 2012. "The Impact of Creditor Protection on Stock Prices in the Presence of Liquidity Crises: Theory and Cross-country Evidence," CESifo Working Paper Series 3765, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_3765
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    File URL: http://www.cesifo-group.de/DocDL/cesifo1_wp3765.pdf
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    References listed on IDEAS

    as
    1. Guillermo A. Calvo & Alejandro Izquierdo & Ernesto Talvi, 2006. "Phoenix Miracles in Emerging Markets: Recovering without Credit from Systemic Financial Crises," Research Department Publications 4474, Inter-American Development Bank, Research Department.
    2. John D. Burger & Francis E. Warnock, 2006. "Local Currency Bond Markets," IMF Staff Papers, Palgrave Macmillan, vol. 53(si), pages 1-7.
    3. Dmitry Livdan & Horacio Sapriza & Lu Zhang, 2009. "Financially Constrained Stock Returns," Journal of Finance, American Finance Association, vol. 64(4), pages 1827-1862, August.
    4. Arturo Galindo & Alejandro Micco, 2005. "Creditor Protection and Credit Volatility," Research Department Publications 4401, Inter-American Development Bank, Research Department.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    liquidity crisis; creditor protection; stock volatility; credit crunch;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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