NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Institutional Weakness and Stock Price Volatility

Galina Hale, Assaf Razin, Hui Tong

NBER Working Paper No. 12127
Issued in March 2006
NBER Program(s):International Finance and Macroeconomics, Asset Pricing

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.

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Document Object Identifier (DOI): 10.3386/w12127

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