Credit Crunch, Creditor Protection, and Asset Prices
42 Pages Posted: 7 Jan 2009 Last revised: 6 Sep 2022
Date Written: August 31, 2008
Abstract
This working paper was written by Galina Hale (Federal Reserve Bank of San Francisco), Assaf Razin (Tel-Aviv University, Cornell University, Centre for Economic Policy Research, National Bureau of Economic Research and CESifo) and Hui Tong (International Monetary Fund).
In a Tobin's q model with productivity and liquidity shocks, we study the mechanism through which strong creditor protection increases the level and lowers the volatility of stock market prices. There are two channels at work: (1) the Tobin's q value under a credit crunch regime increases with creditor protection; and, (2) the probability of a credit crunch falls for given stochastic processes of underlying shocks when creditor protection improves.
We test these predictions by using cross-country panel regressions of the stock market price level and volatility, in 40 countries, over the period from 1984 to 2004, at annual frequency. We create indicators for liquidity shocks based on quantity and price measures. Estimated probabilities of big shocks to liquidity are used as forecasts of credit crunch. We find broad empirical support for the hypothesis that creditor protection increases the stock market price level and reduces its volatility directly and via its negative effect on the probability of credit crunch. Our empirical findings are robust to multiple specifications.
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Balance Sheet Effects, Bailout Guarantees and Financial Crises
By Martin Schneider and Aaron Tornell
-
Hedging and Financial Fragility in Fixed Exchange Rate Regimes
By A. Craig Burnside, Martin Eichenbaum, ...
-
By Francis E. Warnock and John D. Burger
-
By John D. Burger and Francis E. Warnock
-
Emerging Local Currency Bond Markets
By John D. Burger, Francis E. Warnock, ...
-
Why Do Emerging Market Economies Borrow in Foreign Currency?
-
Foreign Participation in Local Currency Bond Markets
By John D. Burger and Francis E. Warnock
-
Foreign Participation in Local-Currency Bond Markets
By Francis E. Warnock and John D. Burger
-
A Corporate Balance Sheet Approach to Currency Crises
By Philippe Aghion, Abhijit V. Banerjee, ...