DP6658 Creditor Protection, Contagion, and Stock Market Price Volatility

Author(s): Galina B Hale, Assaf Razin, Hui Tong
Publication Date: January 2008
Keyword(s): credit crunch, Probit estimation, Tobin q
JEL(s): E1, G2
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=6658

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.