Systematic risk, government policy intervention, and dynamic contrarian investments

•We model contrarian investors' behaviors.•The model incorporates their expectations of government policy risk.•When policy risk is low, the optimal solution is to invest.•When policy risk is high, the optimal investment decision is to exit.•Simulation results are consistent with our model predictions.

When systematic risk is high, or the market crashes, most risk-averse investors choose to exit the market; however, there are some contrarian investors who opt to make investments. We model such contrarian behaviors by incorporating investors' expectations of government policies into the conventional risk-return trade-off framework. We show that when policy risk is low and there is a high probability that the market will recover subsequent to government intervention, the optimal solution is for investors to make investments. However, when the policy risk is high and the market has a high probability of deteriorating, the optimal investment decision is to exit. Our simulation results are consistent with the model predictions.