Working Paper: CEPR ID: DP6658
Authors: Galina B. Hale; Assaf Razin; Hui Tong
Abstract: We study a mechanism through which strong creditor protection affect positively the level, and negatively the volatility, of the aggregate stock market price. In a Tobin-q model with liquidity and productivity shocks, two channels are at work: (1) Creditor protection raises the stock value in a credit-constraint regime; (2) Creditor protection lowers the probability of the credit crunch. We confront the key predictions of the model to a panel of 40 countries over the period from 1984 to 2004. We find support to the hypothesis that creditor protection have a positive effect on the level, and a negative effect of the volatility, of stock prices, via the negative effect of the creditor protection on the probability of credit crunch.
Keywords: credit crunch; probit estimation; Tobin's Q
JEL Codes: E1; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Stronger creditor protection (G33) | Higher stock market prices (G19) |
| Stronger creditor protection (G33) | Lower stock market volatility (G17) |
| Stronger creditor protection (G33) | Decreased probability of liquidity crises (F65) |
| Decreased probability of liquidity crises (F65) | Higher stock market prices (G19) |
| Decreased probability of liquidity crises (F65) | Lower stock market volatility (G17) |