Asset Prices with Investor Protection and Survival Analysis of Shareholders in the Cross-Sectional Economy

TL;DR

This paper develops a dynamic asset pricing model considering investor protection levels and shareholder survival in a two-firm economy, revealing how protection quality influences shareholder behavior, asset prices, and economic indicators.

Contribution

It introduces a novel model integrating investor protection and cross-sectional effects, providing insights into shareholder survival and asset pricing dynamics.

Findings

Poorer investor protection reduces stock returns and interest rates.

Cross-section affects shareholder shareholding and asset volatility.

Model aligns with empirical observations on protection and asset prices.

Abstract

In this paper, we consider a dynamic asset pricing model in a cross-sectional economy with two firms where a controlling shareholder cannot divert output in one firm with perfect investor protection for minority shareholders and where he can divert a fraction of output in the other firm with imperfect protection. After obtaining the parameters of asset prices by solving the shareholders' consumption-portfolio problems in equilibrium, our model features the effect of investor protection and cross-section in the economy. Furthermore, some survival analysis of the shareholders is presented and sufficient conditions on extinction of the shareholders are given in either firm. Our numerical results are in line with some empirical evidence: (i) poorer investor protection in the cross-sectional economy enables the controlling shareholder to hold less shares of the firm with perfect protection and more shares of the firm with imperfect protection, decreases stock gross returns of both firms, increases stock volatilities of both firms, and decreases interest rates of the economy; (ii) compared with the economy with the single relative firm, for the firm with perfect protection, cross-section enables the controlling shareholder to hold less shares, decreases stock returns, increases stock volatilities slightly and decreases interest rates, while for the firm with imperfect protection, cross-section enables the controlling shareholder to hold more shares, increases stock returns and volatilities and increases interest rates.