Dynamic Interventions and Informational Linkages

Dynamic Interventions and Informational Linkages

By
Lin William Cong, Steven Grenadier, Yunzhi Hu
Journal of Financial Economics. January
2020, Vol. 135, Issue 1, Pages 1-15

We model a dynamic economy with strategic complementarity among investors and study how endogenous government interventions mitigate coordination failures. We establish equilibrium existence and uniqueness, and we show that one intervention can affect another through altering the public information structure. A stronger initial intervention helps subsequent interventions through increasing the likelihood of positive news, but also leads to negative conditional updates. Our results suggest optimal policy should emphasize initial interventions when coordination outcomes tend to correlate. Neglecting informational externalities of initial interventions results in over- or under-interventions. Moreover, saving smaller funds disproportionally more can generate greater informational benefits at smaller costs.