Credit Constraints and Stock Price Volatility

Assaf Razin, Galina Hale and Hui Tong

No 6310, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: 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.

Keywords: Binding credit constraints; Liquidity crises; Tobin-q investment model (search for similar items in EconPapers)
JEL-codes: E4 F3 G0 (search for similar items in EconPapers)
Date: 2007-05
New Economics Papers: this item is included in nep-fmk and nep-mac
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Working Paper: Credit Constraints and Stock Price Volatility (2007)
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