IDEAS home Printed from
   My bibliography  Save this paper

Investor Protection and Exchange Rates


  • Neng Wang
  • Rui Albuquerque


In the summer of 1997, several East Asian countries experienced a dramatic devaluation of their currencies both in nominal and in real terms, stock prices collapsed and output fell. Later in that year several Latin American countries were also affected, followed by Brazil and Russia in 1998. Johnson et al. (2000) provide evidence to support that the degree of outside minority shareholder protection explain the extent of exchange rate depreciation better than standard macro variables such as broad money growth, total reserves and import coverage. This paper provides an explanation for this finding in the context of a two-country equilibrium model (i.e. Korea vs. US) of real exchange rate determination. We argue that Korean firms are plagued by weak investor protection and entrenched controlling shareholders or entrepreneurs of these firms expropriate output from outside minority shareholders. The ability to expropriate minority shareholders is curbed by the extent of investor protection and by the controlling shareholder's own holdings of the firm as in La Porta et al. (1998, 2002). Because the expropriation is a function of the overall capital stock in the firm, weak investor protection leads to excessive investment rates by the entrepreneur and lower stock market valuations. This pattern is consistent with evidence that suggests that there was over-investment in Korea as well as in other East Asian economies. It is also consistent with the firm-level evidence in Baek et al. (2004) who show evidence of large declines in valuations in Korea during the 1997 financial crisis, particularly so in firms with weaker investor protection (see also Mitton (2002)). There are two goods in the world economy and countries specialize in the production of each good. There is free trade in goods and consumers (also the minority shareholders) can perfectly pool any risks internationally. The exchange rate is determined by the price of the Korean good relative to that of the US good. If Korean consumers have a preference for their home good, then the exchange rate depreciates and the relative price of the Korean good decreases when the demand for its goods decreases. In our model, as in Burstein, Eichenbaum and Rebelo (2003), a financial crisis is associated with a large drop in the net foreign asset position of Korean households. Because Korean households are also the ones with greater preference for their domestic good, this leads to a drop in their demand for the Korean good and a drop in the Korean good price. The upshot is a decline in the real value of the local currency. The magnitude of this exchange rate depreciation depends on the extent of investor protection. Weaker investor protection implies a more severe over-investment problem, more expropriation and lower output and dividend rates. Lower output leads to an overvalued exchange rate and implies greater sensitivity of the exchange rate to the financial crisis. Our model also predicts that a financial crisis that hits two countries that are identical in all respects but have different degrees of investor protection leads to a larger drop in the stock market valuation (denominated in local currency units) in the country with weaker investor protection

Suggested Citation

  • Neng Wang & Rui Albuquerque, 2004. "Investor Protection and Exchange Rates," 2004 Meeting Papers 685, Society for Economic Dynamics.
  • Handle: RePEc:red:sed004:685

    Download full text from publisher

    To our knowledge, this item is not available for download. To find whether it is available, there are three options:
    1. Check below whether another version of this item is available online.
    2. Check on the provider's web page whether it is in fact available.
    3. Perform a search for a similarly titled item that would be available.

    References listed on IDEAS

    1. Hansen, Karsten T. & Heckman, James J. & Mullen, K.J.Kathleen J., 2004. "The effect of schooling and ability on achievement test scores," Journal of Econometrics, Elsevier, vol. 121(1-2), pages 39-98.
    2. Eliana Garces & Duncan Thomas & Janet Currie, 2002. "Longer-Term Effects of Head Start," American Economic Review, American Economic Association, vol. 92(4), pages 999-1012, September.
    3. Carneiro, Pedro & Heckman, James J & Masterov, Dimitriy V, 2005. "Labor Market Discrimination and Racial Differences in Premarket Factors," Journal of Law and Economics, University of Chicago Press, vol. 48(1), pages 1-39, April.
    4. Gary S. Becker & Casey B. Mulligan, 1997. "The Endogenous Determination of Time Preference," The Quarterly Journal of Economics, Oxford University Press, vol. 112(3), pages 729-758.
    5. Jacob A. Mincer, 1974. "Introduction to "Schooling, Experience, and Earnings"," NBER Chapters,in: Schooling, Experience, and Earnings, pages 1-4 National Bureau of Economic Research, Inc.
    6. Pedro Carneiro & James J. Heckman, 2002. "The Evidence on Credit Constraints in Post--secondary Schooling," Economic Journal, Royal Economic Society, vol. 112(482), pages 705-734, October.
    7. Carneiro, Pedro & Heckman, James J., 2003. "Human Capital Policy," IZA Discussion Papers 821, Institute for the Study of Labor (IZA).
    8. Flavio Cunha & James J. Heckman & Susanne M. Schennach, 2010. "Estimating the Technology of Cognitive and Noncognitive Skill Formation," Econometrica, Econometric Society, vol. 78(3), pages 883-931, May.
    9. Elizabeth Caucutt & Lance Lochner, 2004. "Early and Late Human Capital Investments, Credit Constraints, and the Family," 2004 Meeting Papers 129, Society for Economic Dynamics.
    10. James J. Heckman & Jora Stixrud & Sergio Urzua, 2006. "The Effects of Cognitive and Noncognitive Abilities on Labor Market Outcomes and Social Behavior," Journal of Labor Economics, University of Chicago Press, vol. 24(3), pages 411-482, July.
    11. Janet Currie & Duncan Thomas, 2000. "School Quality and the Longer-Term Effects of Head Start," Journal of Human Resources, University of Wisconsin Press, vol. 35(4), pages 755-774.
    12. Jacob A. Mincer, 1974. "Schooling, Experience, and Earnings," NBER Books, National Bureau of Economic Research, Inc, number minc74-1, January.
    13. Flavio Cunha & James J. HECKMAN, 2009. "Investing in our Young People," Rivista Internazionale di Scienze Sociali, Vita e Pensiero, Pubblicazioni dell'Universita' Cattolica del Sacro Cuore, vol. 117(3), pages 387-418.
    14. Currie, Janet & Thomas, Duncan, 1995. "Does Head Start Make a Difference?," American Economic Review, American Economic Association, vol. 85(3), pages 341-364, June.
    15. Cunha, Flavio & Heckman, James J. & Lochner, Lance, 2006. "Interpreting the Evidence on Life Cycle Skill Formation," Handbook of the Economics of Education, Elsevier.
    16. Roland Benabou, 2002. "Tax and Education Policy in a Heterogeneous-Agent Economy: What Levels of Redistribution Maximize Growth and Efficiency?," Econometrica, Econometric Society, vol. 70(2), pages 481-517, March.
    17. Melissa Osborne & Herbert Gintis & Samuel Bowles, 2001. "The Determinants of Earnings: A Behavioral Approach," Journal of Economic Literature, American Economic Association, vol. 39(4), pages 1137-1176, December.
    18. Gary S. Becker & Nigel Tomes, 1994. "Human Capital and the Rise and Fall of Families," NBER Chapters,in: Human Capital: A Theoretical and Empirical Analysis with Special Reference to Education (3rd Edition), pages 257-298 National Bureau of Economic Research, Inc.
    19. Knudsen, Eric I. & Heckman, James J. & Cameron, Judy L. & Shonkoff, Jack P., 2006. "Economic, Neurobiological and Behavioral Perspectives on Building America's Future Workforce," IZA Discussion Papers 2190, Institute for the Study of Labor (IZA).
    20. Aiyagari, S. Rao & Greenwood, Jeremy & Seshadri, Ananth, 2002. "Efficient Investment in Children," Journal of Economic Theory, Elsevier, vol. 102(2), pages 290-321, February.
    21. Murnane, Richard J & Willett, John B & Levy, Frank, 1995. "The Growing Importance of Cognitive Skills in Wage Determination," The Review of Economics and Statistics, MIT Press, vol. 77(2), pages 251-266, May.
    22. Stephen V. Cameron & James J. Heckman, 2001. "The Dynamics of Educational Attainment for Black, Hispanic, and White Males," Journal of Political Economy, University of Chicago Press, vol. 109(3), pages 455-499, June.
    23. Case, Anne & Fertig, Angela & Paxson, Christina, 2005. "The lasting impact of childhood health and circumstance," Journal of Health Economics, Elsevier, vol. 24(2), pages 365-389, March.
    24. Meghir, Costas & Palme, Marten, 2001. "The Effect of a Social Experiment in Education," SSE/EFI Working Paper Series in Economics and Finance 0451, Stockholm School of Economics.
    25. Stephen V. Cameron & James J. Heckman, 1998. "Life Cycle Schooling and Dynamic Selection Bias: Models and Evidence for Five Cohorts of American Males," Journal of Political Economy, University of Chicago Press, vol. 106(2), pages 262-333, April.
    26. Stephen V. Cameron & Christopher Taber, 2004. "Estimation of Educational Borrowing Constraints Using Returns to Schooling," Journal of Political Economy, University of Chicago Press, vol. 112(1), pages 132-182, February.
    27. Richard C. Edwards, 1976. "Individual Traits and Organizational Incentives: What Makes a "Good" Worker?," Journal of Human Resources, University of Wisconsin Press, vol. 11(1), pages 51-68.
    28. Flavio Cunha & James J. Heckman, 2008. "Formulating, Identifying and Estimating the Technology of Cognitive and Noncognitive Skill Formation," Journal of Human Resources, University of Wisconsin Press, vol. 43(4).
    29. Bhargava, Alok, 2012. "Food, Economics, and Health," OUP Catalogue, Oxford University Press, number 9780199663910.
    30. Gordon B. Dahl & Lance Lochner, 2005. "The Impact of Family Income on Child Achievement," NBER Working Papers 11279, National Bureau of Economic Research, Inc.
    31. Blau, David & Currie, Janet, 2006. "Pre-School, Day Care, and After-School Care: Who's Minding the Kids?," Handbook of the Economics of Education, Elsevier.
    32. John M. Barron & Mark C. Berger & Dan A. Black, 2006. "Selective Counteroffers," Journal of Labor Economics, University of Chicago Press, vol. 24(3), pages 385-410, July.
    33. Yoram Ben-Porath, 1967. "The Production of Human Capital and the Life Cycle of Earnings," Journal of Political Economy, University of Chicago Press, vol. 75, pages 352-352.
    34. Heckman, James J, 1995. "Lessons from the Bell Curve," Journal of Political Economy, University of Chicago Press, vol. 103(5), pages 1091-1120, October.
    35. Bruce A. Weinberg, 2001. "An Incentive Model of the Effect of Parental Income on Children," Journal of Political Economy, University of Chicago Press, vol. 109(2), pages 266-280, April.
    Full references (including those not matched with items on IDEAS)

    More about this item


    corporate governance; investor protection; real exchange rate; financial crisis;

    JEL classification:

    • F3 - International Economics - - International Finance
    • G3 - Financial Economics - - Corporate Finance and Governance


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:red:sed004:685. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.