May 2020
Chinaís economic model involves active government intervention in Önancial 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 investorsíinformation acquisition). A trade-o§ arises: governmentís objective to reduce asset price volatility may worsen, rather than improve, information e¢ ciency of asset prices.