Prof. Shaoan Huang, Prof. Gaowang Wang and Dr. Xiaodan Wang of CER at SDU have published an article “Government intervention through informed trading in financial markets” online at the top field journal “Journal of Economic Dynamics and Control” on May, 5, 2022.
By incorporating government in the theoretical framework of market microstructure, the paper examines, under what informational conditions and how to execute strategic trading, the government can effectively stabilize the financial markets; meanwhile, the paper investigates the effects of government intervention on the quality of the financial market. The paper delivers two important messages. First, we find that both the government and the insider can engage in reversed trading strategies, but in opposite directions, which implies that they effectively trade against each other in both periods. This situation arises when the government has very precise information and cares much about its policy goal of price stability. The second important message delivered by our analysis is that government intervention can not only stabilize the financial market but also improve market liquidity and price efficiency simultaneously and that the effectiveness of government intervention is positively related to the government’s information quality.
Abstract: We develop a theoretical model of government intervention in which a government with private information trades strategically with other market participants to achieve its policy goal of stabilizing asset prices. When the government has precise information and prioritizes its policy goal, both the government and the informed insider engage in reversed trading strategies, but they trade against each other. Government intervention can improve both market liquidity and price efficiency, and the effectiveness of government intervention depends crucially on the quality of information possessed by the government.
Keywords: government intervention; trading; price stability; price efficiency
JEL Classifications: D8, G1