NBER Publications by Galina Hale

Data show that better creditor protection is correlated across countries with lower average stock market volatility. Moreover, countries with better creditor protection seem to have suffered lower decline in their stock market indexes during the current financial crisis. To explain this regularity, we use a Tobin q model of investment and show that stronger creditor protection increases the expected level and lowers the variance of stock prices in the presence of credit crunches. There are two main channels through which creditor protection enhances the performance of the stock market: (1) The credit-constrained stock price increases with better protection of creditors; (2) The probability of a credit crunch leading to a binding credit constraint falls with strong protection of creditors. ...

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.

We find an empirical regularity that stronger creditor protection reduces the volatility of stock market prices. We analyze two distinct mechanisms that characterize equity price volatility: government guarantees and creditor protection. Using a Tobin q model, we demonstrate that weak creditor protection that gives rise to government guarantees and tightens credit constraints, increases stock price volatility. Empirically, accounting for the probability of financial crises, we find that government guarantees and weak institutions that tighten credit constraints increase aggregated stock price volatility.