Government Intervention in the Financial Market

Government intervention in the financial market through its own trading fundamentally changes the market's structure, function, behavior and outcome. We develop a general equilibrium framework to study the impact of government trading on market outcome and investor welfare. We show that with incompleteness and asymmetric information, the market equilibrium is in general sub-optimal and government intervention can improve investor welfare even without any additional information. However, the welfare impact of government intervention is sensitive to its policy design and the economy's structural details. In addition, popular policy goals such as informational efficiency, price stability and market liquidity can have different welfare implications. Performance measures for government trades based on market prices can be misleading since these trades also affect prices and welfare.