China s Model of Managing the Financial System

Transcription

1 China s Model of Managing the Financial System Markus Brunnermeier, Princeton University Michael Sockin, University of Texas, Austin Wei Xiong, Princeton University 6th JRC Conference February 17, 2017

2 China s Distinct Economic Structure Central planning is still largely mixed with free markets Dual tracks (market & planning tracks) are present in many sectors The state sector, while much improved, is still less e cient than the private sector, and is large and will likely remain large The government still plays a central role in many aspects Sets agenda for policy reforms Has strong in uence on allocation of key resources scal spending, credit, land,... Provides soft budget constraints to state rms and implicit guarantees to various sectors The uctuations in the nancial system all revolve around government policy, intended or unintended ongoing housing market boom expansion of shadow banking system stock market turmoil in 2015 breakdown of circuit breakers in 2016

3 Policy Risks in Financial Development Unavoidable policy risks complex nancial instruments and entangled nancial structures largely new to policy makers ntense speculation by market participants of government policy may reinforce, and even trigger, policy errors Two related but separate issues 1. Front-running by market may cause the gradualistic approach of "crossing river by touching the stone" to fail in nancial development separately discussed in our other paper "China s Gradualistic Economic Approach and Financial Markets" 2. ntensive government intervention makes noise in policy making a pricing factor government noise attracts market speculation and may get ampli ed

4 Government s Paternalistic Philosophy Large population of inexperienced retail investors retail investors hold 50% of tradable shares and contribute to 90% of trading volume Large price volatility in China s stock markets and heavy turnover highest turnover rate among major stock markets Asset prices often deviate from fundamentals large price di erentials between A-B and A-H stock pairs, e.g., Mei, Scheinkman and Xiong (2009) dramatic warrant bubble in , e.g., Xiong and Yu (2011) CSRC s mission: protect retail investors and stabilize markets

5 Government nterventions in China s Financial System Countercyclical policies and regulations interest rate and bank reserve ratio policy suspension and quota control of PO issuance stamp tax on stock trading mortgage rate and rst payment requirement Direct trading in stock markets national team directed to bail out stock market in summer 2015 Tremendous uncertainty surrounding timing and scale of intervention

6 Required Reserve Ratio in China Active monetary policy: up 32 times, down 4 times from Powerful and direct impact on credit supply, money multiplier

7 PO ssuance in A-Share Markets The government (CSRC) directly controls PO issuance had suspended PO issuance 8 times quantity and allocation of quota

8 Stamp Tax in Stock Trading

9 Conceptual Questions How does government intervention impact market dynamics? How do market participants react to this intervention? do they trade along with or against the government? What is the right objective of government intervention? reduce price volatility or improve informational e ciency?

10 Outline We develop a dynamic framework 1. to justify the need for government intervention 2. to show that intense intervention may alter market dynamics ntensive government intervention makes uncertainty about policy errors a factor in asset prices this factor gets magni ed by market speculation it attracts information acquisition by market participants and distracts them from analyzing economic fundamentals Potential tension between reducing price volatility and improving information e ciency

11 A Model with Perfect nformation Discrete-time with in nitely many periods: t = 0, 1, 2... A risky asset, which pays a stream of dividends over time: D t = θ t + σ D ε D t, ε D t s N (0, 1) θ t is an exogenous asset fundamental: θ t+1 = ρ θ θ t + σ θ εt+1 θ, εθ t+1 s N (0, 1) For now, θ t+1 is publicly observable will be made unobservable later when we introduce information frictions and policy errors

12 A Model with Perfect nformation Noise traders submit random market orders: N t = ρ N N t 1 + σ N ε N t, ε N t s N (0, 1) Price insensitive orders, capturing unstable market forces Meant to capture trading by inexperienced retail investors Rational short-term investors each maximize myopic trading pro t: h i Ut i = max E exp γw i Xt i t+1 j θ t+1, N t with W i t+1 = Rf W + X i t R t+1 and R t+1 = D t+1 + P t+1 R f P t. Equilibrium without any government intervention: Z 1 0 X i t dt = N t

13 Market Breakdown Conjecture a linear equilibrium: P t = 1 R f ρ θ θ t+1 + p N N t Optimal position of each myopic rational investor: h i Xt i = 1 E t D t+1 + P t+1 R f P t = 1 p N ρ N R f γ Var t [D t+1 + P t+1 ] γ σ 2 D + R f 2 N t ρ σ 2 θ θ + pn 2 σ2 N The market breaks down when R f σ N > σn = R f ρ r N. 2γ σ 2 D + R f 2 R f ρ σ 2 θ θ Short-term investors ine ective in trading against noise trader risk, similar to DSSW (1990)

14 Volatility Explosion

15 Government ntervention ntroduce a government that trades the asset and takes a position q +, Xt G = ϑ N,t N t {z } intended intervention Var [ϑ N,t N t j F t 1 ]G t {z } unintended noise the government chooses intervention intensity ϑn,t the amount of unintended noise increases with ϑn,t Government intervention a ects discount rates not cash ows D t distinct from Pastor & Veronesi (2012) and Bond & Goldstein (2015), which focus on interventions that a ect cash ow

16 Government Objective De ne the government objective: choose ϑ N to maximize Ut G = min γ σ Var [ P t (ϑ N,t ) jf t ] ϑ N,t + γ θ Var P t (ϑ N,t ) R f 1 ρ θ θ t+1 jf t Penalty γσ for price volatility, penalty γ θ for price deviation from fundamental Two possible objectives: reducing conditional volatility and improving informational e ciency often treated as equivalent in policy discussions reducing price volatility is more convenient and widely adopted in practice, e.g., in US monetary policy - Stein and Sundarem (2016) The government internalizes the market failure by taking a su ciently large ϑ N,t to prevent market breakdown

17 ntervention Equilibrium Again, we conjecture a linear equilibrium: P t = R f 1 ρ θ θ t + p N N t + P g G t The market clearing R 1 0 X i t dt + X G t = N t implies the market breaks down only when σ N > s ρn (1 ϑ N ) R f R f 2 σn ϑn 2 1 ϑ σ 2 N G ϑ N > 0 mitigates the region of market failure and may prevent failure if su ciently large

18 Volatility Explosion

19 An Extended Model with nformation Frictions Suppose now θ t+1 is unobservable The public information set: Ft M = σ fd s, P s g st ˆθ M t+1 = E θ t+1 j Ft M serves as the anchor of asset valuation ˆN t M = E N t j Ft M is the market perceived noise trading The government has no private information and intervenes Xt G = ϑ ˆN q M ˆN t + Var ϑ ˆN M ˆN t j Ft M 1 Gt with an objective min ϑ N γ σ Var h P t + γ θ Var ϑ ˆN j F M t P t 1 i 1 ϑ ˆN R f θ t+1 j Ft M 1 ρ θ

20 An Extended Model with nformation Frictions Rational short-term investors again trade in the risky aseet Each investor i also chooses a i t 2 f0, 1g to acquire private information about either θ t+1 or future government noise G t+1 : h i 1/2 h i 1/2 st i = θ t+1 + at i τ ε s,i t or gt i = G t at i τ ε g,i t Once again, investors have a myopic objective: " h Ut i = max E max E exp γw i at i 2f0,1g Xt i t+1 j F i t i j F M t 1 #, where F i t = F M t _ a i t si t + 1 a i t g i t

21 Equilibria with Government ntervention A fundamental-centric equilibrium all investors acquire signals about θ t+1 investor trading makes price more informative about θt+1 investors may trade against government, depending on signals A government-centric equilibrium all investors acquire signals about G t+1 occurs when the government intervention is su ciently intensive price may be less informative about θt+1 investors all trade along the government, making price volatility lower and allowing government to trade less A mixed equilibrium some investors acquire signals about θ t+1 some about G t+1

22 Market Equilibrium with a Single Government Objective Three cases: 1) γ σ = 0, γ θ 6= 0; 2)γ θ = 0, γ σ 6= 0; 3)γ θ = 0, γ σ = 0

23 Market Equilibrium with a Mixed Government Objective γ θ = 1 and varying γ σ

24 γ θ = 1 and γ σ = 1.25

25 Boundary between Government- and Fundamental-Centric Equilibria

26 Key nsights Government intervention helps to stabilize nancial markets unregulated markets can be highly volatile and might break down when noise trader risk is su ciently large Adverse e ects: active government intervention renders noise in government policy a pricing factor intervention can cause investors to speculate on government noise rather than fundamentals, which ampli es e ects of policy errors Tension between objectives of reducing price volatility and improving informational e ciency while price volatility is lower with intervention, informational e ciency can be worse

27 Risks in China s Financial System Commonly concerned risks Noise trader risk created by inexperienced retail investors Rising leverage across the nation Overheating housing markets Another risk: policy errors magni ed by nancial market speculation the stock market turmoil in summer 2015 the breakdown of the circuit breaker in January 2016 the exchange rate crash in August 2015