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Stabilizing the Financial Markets through Communication and Informed Trading

Guo, Qi and Huang, Shao'an and Wang, Gaowang (2024): Stabilizing the Financial Markets through Communication and Informed Trading. Forthcoming in: Journal of Financial Markets

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We develop a model of government intervention with information disclosure in which a government with two private signals trades directly in financial markets to stabilize asset prices. Government intervention through informed trading stabilizes financial markets and affects market quality (market liquidity and price efficiency) through a noise channel and an information channel. Information disclosure negatively affects financial stability by deteriorating the information advantages of the government, while its final effects on market quality hinge on the relative sizes of the noise effect and the information effect. Under different information disclosure scenarios, there exist potential tradeoffs between financial stability and price efficiency.

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