China's Model of Managing the Financial System

Transcription

1 JRCPPF Escalating Risks China's Model of Managing the Financial System Markus K. Brunnermeier Michael Sockin Wei Xiong Discussion by Lin William Cong University of Chicago Booth School of Business Feb, 2017

2 Contribution and Significance Government Intervention and Impact on Price Dynamics Context of China s Financial System Stock market crash in Real, Important, and Timely. Slide 1/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

3 Contribution and Significance Government Intervention and Impact on Price Dynamics Context of China s Financial System Stock market crash in Real, Important, and Timely. Slide 1/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

4 Contribution and Significance Government Intervention and Impact on Price Dynamics Context of China s Financial System Stock market crash in Real, Important, and Timely. Slide 1/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

5 What Happened in China in 2015? A taxi-driver s tale. Slide 2/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

6 What Happened in China in 2015? A taxi-driver s tale. Slide 3/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

7 Fund Managers Speculation All about interventions: Slide 4/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

8 Closed-door Round-Table Discussion Anomalous Movements, Reducing Volatility. From "Saving China's Stock Market" by Yi Huang, Jianjun Miao, and Pengfei Wang Slide 5/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

9 Important China s Economy and Financial Markets. By the end of September 2015, 42 trillion RMB, daily volume of August 2015 was billion RMB Slide 6/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

10 Important New Investors Dynamics Slide 7/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

11 Important International Ramifications Currency Devaluation August 2015 Daily reference rate down 1.9 percent, largest since Jan 1994 Implications for other countries Unconventional monetary policy in OECDs. Introduction of Euros (Gopinath et al. (2015)) Economic stimulus after the global recession. Our understanding of business (credit) cycles and allocational efficiency. Caballero et. al (1994), Cooper et al (1993), Kiyotaki & Moore (1997), Ramey & Watson (1997) Slide 8/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

12 Important International Ramifications Currency Devaluation August 2015 Daily reference rate down 1.9 percent, largest since Jan 1994 Implications for other countries Unconventional monetary policy in OECDs. Introduction of Euros (Gopinath et al. (2015)) Economic stimulus after the global recession. Our understanding of business (credit) cycles and allocational efficiency. Caballero et. al (1994), Cooper et al (1993), Kiyotaki & Moore (1997), Ramey & Watson (1997) Slide 8/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

13 Important International Ramifications Currency Devaluation August 2015 Daily reference rate down 1.9 percent, largest since Jan 1994 Implications for other countries Unconventional monetary policy in OECDs. Introduction of Euros (Gopinath et al. (2015)) Economic stimulus after the global recession. Our understanding of business (credit) cycles and allocational efficiency. Caballero et. al (1994), Cooper et al (1993), Kiyotaki & Moore (1997), Ramey & Watson (1997) Slide 8/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

14 Timely Impact and unintended consequences of market interventions. Brunnermeier, Sockin, & Xiong (2017), Bai, Hsieh, & Song (2016), Hachem & Song (2016), Huang, Pagano, & Panizza (2016), Cong & Ponticelli (2017), Chen, He, & Liu (2017) Ongoing reforms of financial markets Reform Bull : SOE reforms and transition from export-based to consumption-based Liquidity Bull : China s version of QE Capital Bull : abundance capital and excessive shadow leverage Registration-based IPO, Microstructure Reforms (T + 1, down limit, circuit breaker), internationalization of RMB Ongoing reforms and interventions in other countries. Slide 9/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

15 Timely Impact and unintended consequences of market interventions. Brunnermeier, Sockin, & Xiong (2017), Bai, Hsieh, & Song (2016), Hachem & Song (2016), Huang, Pagano, & Panizza (2016), Cong & Ponticelli (2017), Chen, He, & Liu (2017) Ongoing reforms of financial markets Reform Bull : SOE reforms and transition from export-based to consumption-based Liquidity Bull : China s version of QE Capital Bull : abundance capital and excessive shadow leverage Registration-based IPO, Microstructure Reforms (T + 1, down limit, circuit breaker), internationalization of RMB Ongoing reforms and interventions in other countries. Slide 9/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

16 Timely Impact and unintended consequences of market interventions. Brunnermeier, Sockin, & Xiong (2017), Bai, Hsieh, & Song (2016), Hachem & Song (2016), Huang, Pagano, & Panizza (2016), Cong & Ponticelli (2017), Chen, He, & Liu (2017) Ongoing reforms of financial markets Reform Bull : SOE reforms and transition from export-based to consumption-based Liquidity Bull : China s version of QE Capital Bull : abundance capital and excessive shadow leverage Registration-based IPO, Microstructure Reforms (T + 1, down limit, circuit breaker), internationalization of RMB Ongoing reforms and interventions in other countries. Slide 9/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

17 Model Setup Grossman-Stiglitz REE with a large player and OLG agents Dividends D t = θ t + σ D ɛ D t persistent component (fundamental) AR(1) θ t = ρ θ θ t 1 + σ θ ɛ θ t Excess Payoff: R t+1 = D t+1 + P t+1 R f P t Participants: noise traders, rational traders (OLG), government Slide 10/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

18 Model Setup Noise traders: N t = ρ N N t 1 + σ N ɛ N t Investors: i [0, 1], live for one period Endowed with wealth W CARA utility U i t = E[ exp( γw i t+1 ) F t] Government Minimizes price vol and deviation from fundamental ] min γ σ Var t [ P t ] + γ θ Var t [P t 1 R f ρ θ θ t+1 γ σ risk aversion for price vol; γ θ risk aversion for deviation. Slide 11/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

19 Model Setup Noise traders: N t = ρ N N t 1 + σ N ɛ N t Investors: i [0, 1], live for one period Endowed with wealth W CARA utility U i t = E[ exp( γw i t+1 ) F t] Government Minimizes price vol and deviation from fundamental ] min γ σ Var t [ P t ] + γ θ Var t [P t 1 R f ρ θ θ t+1 γ σ risk aversion for price vol; γ θ risk aversion for deviation. Slide 11/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

20 Key Results Benchmark: perfect information No intervention, price vol explode, and market breakdown when σ N is large. Noise trading + Investor myopia Role for the government to reduce market vol and stabilize the market. Intervention to reduce price volatility consistent with improving price efficiency (always the case?). Slide 12/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

21 Key Results With information frictions: unobservable fundamentals No intervention, reducing price volatility consistent with improving price efficiency. Intervention introduces additional noise. Speculation on gov noise. Price vol reduced at the expense of price efficiency. Gov-centric equilibrium has less gov trading Gov pre-commitment and equilibrium multiplicity. Slide 13/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

22 Comment 1: Government s Objective Reducing both asset price deviation from fundamentals and price vol. Alternative 1: preventing crash Slide 14/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

23 Comment 1: Government s Objective Alternative 2: Favoring State-connected Firms e.g., Song, Storesletten, & Zilibotti (2011); Cong & Ponticelli (2017) Alternative 3: Social Stability Agents with imperfect signal x it Prior of economy fundamental θ t Government intervention m t Market breaks down if too many run A run Government minimizes Z(m t, z, θ t )A stay t threshold), L is loss upon failure. Learning or info acquisition about z Government-centric vs Fundamental-centric t > m t + θt L + K(m) (or Slide 15/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

24 Comment 1: Government s Objective Alternative 2: Favoring State-connected Firms e.g., Song, Storesletten, & Zilibotti (2011); Cong & Ponticelli (2017) Alternative 3: Social Stability Agents with imperfect signal x it Prior of economy fundamental θ t Government intervention m t Market breaks down if too many run A run Government minimizes Z(m t, z, θ t )A stay t threshold), L is loss upon failure. Learning or info acquisition about z Government-centric vs Fundamental-centric t > m t + θt L + K(m) (or Slide 15/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

25 Comment 2: Minimization of Pricing Error Reducing both asset price deviation from fundamentals and price vol. The Bias-Variance Trade-off (Decomposition): E(y 0 ˆf (x 0 )) 2 = Var(ˆf (x 0 )) + [Bias(ˆf (x 0 ))] 2 + Var(ɛ) Slide 16/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

26 Comment 2: Minimization of Pricing Error Reducing both asset price deviation from fundamentals and price vol. The Bias-Variance Trade-off (Decomposition): E(y 0 ˆf (x 0 )) 2 = Var(ˆf (x 0 )) + [Bias(ˆf (x 0 ))] 2 + Var(ɛ) Slide 16/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

27 Comment 2: Minimization of Pricing Error Penalty for Pricing Errors E [ ( t D t P t (υ ˆN,t ))2 F M t 1 ] = Var( t D t ) + E[ t D t ] 2 + Var[P t (υ ˆN,t )] +E[P t (υ ˆN,t )] 2 2E[( t D t )P t (υ ˆN,t )] = Var( t D t ) + Var[P t (υ ˆN,t )] + E [ P t (υ ˆN,t ) E[ t D t ] ] 2 Natural interpretation of the government s objective. For equilibrium existence, Bias-Variance are qualitatively equivalent. But unclear in general. Slide 17/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

28 Comment 3: Information Design and Intervention Costs Information Design vs Mechanism Design (Bergemann and Morris (2016)) Information Structure Design & Symmetric Learning Intervention impact uncertain, effectiveness less than expected. Alteration of the informational environment. Goldstein and Huang (2016), Cong et al (2017) Asymmetric Information and Learning Footnote 11; Signaling (Angeletos et al (2006)); Reputation (Huang (2017)) Multiplicity and commitment Slide 18/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

29 Comment 3: Information Design and Intervention Costs Information Design vs Mechanism Design (Bergemann and Morris (2016)) Information Structure Design & Symmetric Learning Intervention impact uncertain, effectiveness less than expected. Alteration of the informational environment. Goldstein and Huang (2016), Cong et al (2017) Asymmetric Information and Learning Footnote 11; Signaling (Angeletos et al (2006)); Reputation (Huang (2017)) Multiplicity and commitment Slide 18/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

30 Comment 3: Information Design and Intervention Costs Information Design vs Mechanism Design (Bergemann and Morris (2016)) Information Structure Design & Symmetric Learning Intervention impact uncertain, effectiveness less than expected. Alteration of the informational environment. Goldstein and Huang (2016), Cong et al (2017) Asymmetric Information and Learning Footnote 11; Signaling (Angeletos et al (2006)); Reputation (Huang (2017)) Multiplicity and commitment Slide 18/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

31 Comment 3: Information Design and Intervention Costs Intervention Costs Taxpayers money, and investment risks in interventions. Political capital Disrupted IPO reform and currency internalization Firing of head of CSRC, Xiao Gang; imprisonment of Citic officials. Impact of Intervention Costs Interior optimal intervnetion absent cost of intervention. What is the welfare gains and losses in gov-centric vs fundamental-centric equilibrium? Cost matters when there is dynamic information design. Relevant for multiple interventions: Cong et al (2017). Slide 19/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

32 Comment 3: Information Design and Intervention Costs Intervention Costs Taxpayers money, and investment risks in interventions. Political capital Disrupted IPO reform and currency internalization Firing of head of CSRC, Xiao Gang; imprisonment of Citic officials. Impact of Intervention Costs Interior optimal intervnetion absent cost of intervention. What is the welfare gains and losses in gov-centric vs fundamental-centric equilibrium? Cost matters when there is dynamic information design. Relevant for multiple interventions: Cong et al (2017). Slide 19/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

33 Comment 3: Information Design and Intervention Costs Intervention Costs Taxpayers money, and investment risks in interventions. Political capital Disrupted IPO reform and currency internalization Firing of head of CSRC, Xiao Gang; imprisonment of Citic officials. Impact of Intervention Costs Interior optimal intervnetion absent cost of intervention. What is the welfare gains and losses in gov-centric vs fundamental-centric equilibrium? Cost matters when there is dynamic information design. Relevant for multiple interventions: Cong et al (2017). Slide 19/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

34 Comment 3: Information Design and Intervention Costs Intervention Costs Taxpayers money, and investment risks in interventions. Political capital Disrupted IPO reform and currency internalization Firing of head of CSRC, Xiao Gang; imprisonment of Citic officials. Impact of Intervention Costs Interior optimal intervnetion absent cost of intervention. What is the welfare gains and losses in gov-centric vs fundamental-centric equilibrium? Cost matters when there is dynamic information design. Relevant for multiple interventions: Cong et al (2017). Slide 19/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

35 Comment 3: Information Design and Intervention Costs Intervention Costs Taxpayers money, and investment risks in interventions. Political capital Disrupted IPO reform and currency internalization Firing of head of CSRC, Xiao Gang; imprisonment of Citic officials. Impact of Intervention Costs Interior optimal intervnetion absent cost of intervention. What is the welfare gains and losses in gov-centric vs fundamental-centric equilibrium? Cost matters when there is dynamic information design. Relevant for multiple interventions: Cong et al (2017). Slide 19/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

36 Comment 4: Cum Dividend Return and Variance By p7 R t+1 = D t+1 + P t+1 R f P t = (θ t+1 + σ D ɛ D t+1) + (p θ θ t+1 + p N N t+1 ) R f P t = (1 + p θ )(ρ θ θ t + σ θ ɛ θ t+1) + σ D ɛ D t+1 Conditional Variance +(p N (ρ N N t + σ N ɛ N t+1)) R f P t Var t (R t+1 ) = (1 + p θ ) 2 σ 2 θ + σ2 D + p2 N σ2 N (1) where p θ = 1/(R f ρ θ ). which differs from the equation on p9. Conditional mean: (1 + p θ )ρ θ θ t + p N ρ N N t R f (p θ θ t + p N N t ) = ((1 + p θ )ρ θ R f p θ )θ t + p N (ρ N R f )N t Slide 20/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

37 Comment 4: Cum Dividend Return and Variance cum dividend? D t + P t linear in θ t and noise? No qualitative changes to the results. But should be consistent. Slide 21/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

38 Other Comments 1 Uniqueness of p N Focus on less negative root of p N because it converges when σ N 0 What about σ N? Is the other root more stable? Not an issue in Wincoop (2006, 2008) 2 Microfoundation of government noise and investor learning. Footnote 11: Gov possesses private signals. Slide 22/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

39 Other Comments 1 Uniqueness of p N Focus on less negative root of p N because it converges when σ N 0 What about σ N? Is the other root more stable? Not an issue in Wincoop (2006, 2008) 2 Microfoundation of government noise and investor learning. Footnote 11: Gov possesses private signals. Slide 22/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

40 Other Comments 1 Role of leverage and deleveraging-driven firesale. 2 Empirical predictions or evidence that the gov intervention is indeed a priced factor. 3 coordination failures among regulatory agencies. State Council, PBOC, CBRC, CSRC, and CIRC. 4 Online Appendix. Slide 23/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

41 Other Comments 1 Role of leverage and deleveraging-driven firesale. 2 Empirical predictions or evidence that the gov intervention is indeed a priced factor. 3 coordination failures among regulatory agencies. State Council, PBOC, CBRC, CSRC, and CIRC. 4 Online Appendix. Slide 23/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

42 Other Comments 1 Role of leverage and deleveraging-driven firesale. 2 Empirical predictions or evidence that the gov intervention is indeed a priced factor. 3 coordination failures among regulatory agencies. State Council, PBOC, CBRC, CSRC, and CIRC. 4 Online Appendix. Slide 23/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

43 Other Comments 1 Role of leverage and deleveraging-driven firesale. 2 Empirical predictions or evidence that the gov intervention is indeed a priced factor. 3 coordination failures among regulatory agencies. State Council, PBOC, CBRC, CSRC, and CIRC. 4 Online Appendix. Slide 23/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

44 Recap 1 Realistic, important, and timely. 2 More research on the effectiveness and unintended consequences of interventions. 3 Empirical studies and policy applications. Slide 24/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

45 Recap 1 Realistic, important, and timely. 2 More research on the effectiveness and unintended consequences of interventions. 3 Empirical studies and policy applications. Slide 24/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System

46 Recap 1 Realistic, important, and timely. 2 More research on the effectiveness and unintended consequences of interventions. 3 Empirical studies and policy applications. Slide 24/24 Discussion by Will Cong (Chicago Booth) China s Model of Managing the Financial System