Working Paper: NBER ID: w27171
Authors: Markus K. Brunnermeier; Michael Sockin; Wei Xiong
Abstract: China's economic model involves active government intervention in financial markets. We develop a theoretical framework in which interventions prevent a market breakdown and a volatility explosion caused by the reluctance of short-term investors to trade against noise traders. In the presence of information frictions, the government can alter market dynamics since the noise in its intervention program becomes an additional factor driving asset prices. More importantly, this may divert investor attention away from fundamentals and totally toward government interventions (as a result of complementarity in investors' information acquisition). A trade-off arises: government's objective to reduce asset price volatility may worsen, rather than improve, information efficiency of asset prices.
Keywords: China; financial system; government intervention; market dynamics; information efficiency
JEL Codes: G01; G14; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government intervention (O25) | Prevent market breakdowns (G18) |
| Government intervention (O25) | Prevent volatility explosions (E32) |
| Government intervention (O25) | Reduced information efficiency (G14) |
| Intensity of government intervention (H19) | Market dynamics (D49) |
| Stronger government intervention (H10) | Lower volatility (G19) |
| Stronger government intervention (H10) | Reduced information efficiency (G14) |