Working Paper: CEPR ID: DP7357
Authors: Galina B. Hale; Assaf Razin; Hui Tong
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.
Keywords: credit crunch; Tobin's Q
JEL Codes: F3; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| better creditor protection (G33) | lower average stock market volatility (G17) |
| better creditor protection (G33) | smaller decline in stock market indexes during financial crises (G01) |
| stronger creditor rights (G33) | lower incidence of credit crunches (F65) |
| creditor protection (G33) | mitigates volatility of stock prices (G17) |
| creditor protection (G33) | influences stock market performance (G10) |
| creditor protection (G33) | reduces volatility of the credit market (G19) |