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 mar-kets. Our argument stems from the decentralised trading practice and the presumable discrepancy be-tween ‘informed’ and ‘uninformed’ traders’ valuations. Since informed traders’ valuations are likely to be less dispersed, a transaction tax penalises informed trades disproportionately, leading to increased volatil-ity. 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 transac-tion costs is found to have a significant positive effect on volatility.
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Bibliographic InfoPaper provided by Bank of Finland in its series Research Discussion Papers with number 11/2006.
Length: 25 pages
Date of creation: 10 Oct 2006
Date of revision:
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.
- Markku Lanne & Timo Vesalay, 2005. "The Effect of a Transaction Tax on Exchange Rate Volatility," Economics Working Papers ECO2005/19, European University Institute.
- 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-2006-10-21 (All new papers)
- NEP-CBA-2006-10-21 (Central Banking)
- NEP-FIN-2006-10-21 (Finance)
- NEP-FMK-2006-10-21 (Financial Markets)
- NEP-IFN-2006-10-21 (International Finance)
- NEP-MST-2006-10-21 (Market Microstructure)
- NEP-PBE-2006-10-21 (Public Economics)
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