On November 8, 2016, the Indian government made a surprise announcement that certain currency notes (representing 86% of the currency then in circulation) would no longer be legal tender (although they could be deposited in banks for a limited period). The stated reason for this sudden ‘demonetization’ was to combat tax evasion and corruption associated with ‘unaccounted-for’ cash. In our paper, we use daily stock price data from the Prowess database (maintained by the Centre for Monitoring the Indian Economy (CMIE)) to compute abnormal returns for firms on the Indian stock market around this event. In particular, we compare patterns of abnormal returns for different subsamples of firms defined by industry, ownership structure, and other characteristics.

There is little evidence that sectors thought to be associated with greater tax evasion or corruption experienced significantly different returns. The real estate sector, where payments in unaccounted-for cash are thought to be a widespread means of tax evasion, experienced an abnormal return of between -2% and -4%. We argue, using a simple theoretical framework, that this is consistent with a market expectation of only a modest decline in tax evasion. Similarly, we find no detectable relationship between the abnormal returns we compute and an index of sector-level perceptions of the prevalence of bribery (constructed by Transparency International based on global survey data). Overall, these findings suggest that the market expected the effects of demonetization on corruption and tax evasion to be modest at best.

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