Working Paper: CEPR ID: DP6310
Authors: Galina B. Hale; Assaf Razin; Hui Tong
Abstract: This paper addresses how creditor protection affects the volatility of stock market prices. Credit protection reduces the probability of oscillations between binding and non-binding states of the credit constraint; thereby lowering the rate of return variance. We test this prediction of a Tobin?s q model, by using cross-country panel regression on stock price volatility in 40 countries over the period from 1984 to 2004. Estimated probabilities of a liquidity crisis are used as a proxy for the probability that credit constraints are binding. We find support for the hypothesis that institutions that help reduce the probability of oscillations between binding and non-binding states of the credit constraint also reduce asset price volatility.
Keywords: binding; credit constraints; liquidity crises; Tobin's q investment model
JEL Codes: E4; F3; G0
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Stronger creditor protection (G33) | Lower probability of oscillations between binding and non-binding credit constraints (E19) |
| Lower probability of oscillations between binding and non-binding credit constraints (E19) | Lower variance of stock returns (G17) |
| Stronger creditor protection (G33) | Lower variance of stock returns (G17) |
| Weak creditor protection (G33) | Higher probability of liquidity crises (F65) |
| Higher probability of liquidity crises (F65) | Increased stock return volatility (G17) |
| Stronger creditor protection (G33) | Lower stock price volatility (G17) |