This paper can be accessed by subscription to The authors propose a mathematical model which Economic Papers. combines its own signals and the signals gained from observing financial markets, along with respective Government Intervention and Information weights. The weights depend on the precision of the Aggregation by Prices, Philip Bond and Itay government’s signal and the informativeness of Goldstein, Journal of Finance, 70, 6, December 2015, market prices. Situations in which the government pp. 2777-2812. did not utilise information in an optimal way ex post are also considered. This article explores government intervention in private businesses. Efficient interventions depend on Analysis of the model shows that government usage economic conditions, about which a government of market prices as an input for policy might damage often has only limited information. The authors the informational content of the prices themselves. contend that it is efficient for governments to follow at This is because increasing government reliance on least partially the market and make interventions market prices affects the risk-return trade-off faced by based on observed stock prices. However, since speculators. Thus, there are cases in which the price information is endogenous to government government would achieve a better outcome by policy, it might, in some cases, be optimal for the limiting its reliance on market prices and increasing government to commit to limited reliance on market its informational content. However, the government prices in order to avoid harming trading incentives. always benefits from some reliance on market prices. An important motivation for government intervention The authors also noted that government is the externalities that firms and financial institutions transparency could have negative effects on the impose on the rest of the economy. This was one of market by reducing trading incentives and price the major reasons behind the US Government informativeness. Whilst this paper is focused on of large financial institutions, such as Bear ‘bailouts’ market-based government policy, it is noted that the Stearns and the automobile industry. However, a analysis and results could apply more generally to long-standing concern is that governments only have other non-government actions based on price. limited information, preventing them from intervening The reference list consists of forty-three items. in the most efficient way. A common tenet in finance is that, as the market price contains much The article can be accessed by subscription to the information, it could potentially provide valuable Journal of Finance. guidance for governments.
This paper can be accessed by subscription to Economic Papers. Government Intervention and Information Aggregation by Prices, Philip Bond and Itay Goldstein, Journal of Finance, 70, 6, December 2015, pp. 2777-2812. This article explores government intervention in private businesses. Efficient interventions depend on economic conditions, about which a government often has only limited information. The authors contend that it is efficient for governments to follow at least partially the market and make interventions based on observed stock prices. However, since price information is endogenous to government policy, it might, in some cases, be optimal for the government to commit to limited reliance on market prices in order to avoid harming trading incentives. An important motivation for government intervention is the externalities that firms and financial institutions impose on the rest of the economy. This was one of the major reasons behind the US Government ‘bailouts’ of large financial institutions, such as Bear Stearns and the automobile industry. However, a long-standing concern is that governments only have limited information, preventing them from intervening in the most efficient way. A common tenet in finance is that, as the market price contains much information, it could potentially provide valuable guidance for governments. The authors propose a mathematical model which combines its own signals and the signals gained from observing financial markets, along with respective weights. The weights depend on the precision of the government’s signal and the informativeness of market prices. Situations in which the government did not utilise information in an optimal way ex post are also considered. Analysis of the model shows that government usage of market prices as an input for policy might damage the informational content of the prices themselves. This is because increasing government reliance on market prices affects the risk-return trade-off faced by speculators. Thus, there are cases in which the government would achieve a better outcome by limiting its reliance on market prices and increasing its informational content. However, the government always benefits from some reliance on market prices. The authors also noted that government transparency could have negative effects on the market by reducing trading incentives and price informativeness. Whilst this paper is focused on market-based government policy, it is noted that the analysis and results could apply more generally to other non-government actions based on price. The reference list consists of forty-three items. The article can be accessed by subscription to the Journal of Finance.
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