The Effect of a Transaction Tax on Exchange Rate Volatility
AbstractWe argue that a transaction tax is likely to amplify, not dampen, volatility in the foreign exchange markets. Our argument stems from the decentralized trading practice and the presumable discrepancy between 'informed' and 'uninformed' traders' valuations. Since informed 'traders' valuations are likely to be less dispersed, a transaction tax penalizes informed trades disproportionately, leading to increased volatility. Empirical support for this prediction is found by investigating the effect of transaction costs on the volatility of DEM/USD and JPY/USD returns. High-frequency data are used and an increase in transaction costs is found to have a significant positive effect on volatility.
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Bibliographic InfoPaper provided by European University Institute in its series Economics Working Papers with number ECO2005/19.
Date of creation: 2005
Date of revision:
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Transaction tax; exchange rates; volatility;
Other versions of this item:
- Markku Lanne & Timo Vesala, 2010. "The effect of a transaction tax on exchange rate volatility," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 15(2), pages 123-133.
- Lanne , Markku & Vesala , Timo, 2006. "The effect of a transaction tax on exchange rate volatility," Research Discussion Papers 11/2006, Bank of Finland.
- F31 - International Economics - - International Finance - - - Foreign Exchange
- F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-09-11 (All new papers)
- NEP-CBA-2006-09-11 (Central Banking)
- NEP-FIN-2006-09-11 (Finance)
- NEP-FMK-2006-09-11 (Financial Markets)
- NEP-IFN-2006-09-11 (International Finance)
- NEP-MST-2006-09-11 (Market Microstructure)
- NEP-PBE-2006-09-11 (Public Economics)
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