Munich Personal RePEc Archive

Stabilizing the Financial Markets through Informed Trading

Guo, Qi and Huang, Shao'an and Wang, Gaowang (2022): Stabilizing the Financial Markets through Informed Trading.

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We develop a model of government intervention with information disclosure in which the government with two private signals trades against other market participants to stabilize the financial markets. The government trades optimally based more on the price target than the noisy signal about the fundamentals. Information disclosure harms financial stability by deteriorating the information advantages of the government. Releasing the price target diminishes noises in financial markets and decreases market liquidity, while releasing the fundamental signal reduces private information in financial markets and improves market liquidity; and the tradeoffs of releasing both signals depend on its policy weights. Releasing the fundamental signal raises price efficiency effectively, while releasing the price target has subtle effects on price efficiency. Under different scenarios of information disclosure, there exist tradeoffs between financial stability and price efficiency.

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