The Hazards of Propping Up: Bubbles and Chaos

TL;DR

This paper demonstrates that government intervention in financial markets can inadvertently cause long-term bubbles and chaos, especially when critical levels of committed capital are reached, influenced by market impact and exposure targets.

Contribution

It reveals the long-term destabilizing effects of government propping up, highlighting the conditions under which chaos and bubbles emerge.

Findings

Intervention can lead to long-term bubbles.

Critical capital levels trigger chaotic market behavior.

Market impact and exposure targets influence stability.

Abstract

In the current environment of financial distress, many governments are likely to soon become major holders of financial assets, but the policy debate focuses only on the likelihood and extent of short-term market stabilization. This paper shows that government intervention and propping up are likely to lead to long-term bubbles and even wildly chaotic behavior. The discontinuities occur when the committed capital reaches a critical amount that depends on just two parameters: the market impact of trading and the target exposure percentage.