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Myopic Traders, Efficiency and Taxation

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Author Info
Alexander Gümbel ()
Abstract

This paper explores the welfare implications of a securities transaction tax when informed traders act under short-term objectives. The model presented features speculators who can trade on information of differing time horizons, trade by fully rational uninformed agents, endogenous asset prices and profit maximising firms that can use information contained in stock prices to improve their investment decision. The only value enhancing investment available to firms requires a long-term investment. Therefore investment efficiency can only be improved if stock prices contain long-term information. It is shown that when informed traders act under short-term objectives, a subsidy on short-term trade can improve welfare. This is because trade by short-term informed speculators exerts a positive externality over the profitability of long-term informed trade. A subsidy on short-term trade thus increases the amount of trade on long-term information in equilibrium. As a result stock prices contain more long-term information, which improves investment efficiency. The model takes full account of the effect of a tax on market liquidity and welfare for all market participants.

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Paper provided by Oxford Financial Research Centre in its series OFRC Working Papers Series with number 2000fe05.

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Date of creation: 2000
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Handle: RePEc:sbs:wpsefe:2000fe05

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  1. Vives, Xavier, 1995. "Short-Term Investment and the Informational Efficiency of the Market," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 8(1), pages 125-60. [Downloadable!] (restricted)
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  2. Dow, J & Rahi, R, 1997. "Informed Trading, Investment, and Welfare," Economics Working Papers eco97/03, European University Institute.
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  3. Ross, S.A., 1989. "Commentary: Using Tax Policy To Curb Speculative Short-Term Trading," Papers t3, Columbia - Center for Futures Markets.
  4. Shleifer, Andrei & Vishny, Robert W, 1997. " The Limits of Arbitrage," Journal of Finance, American Finance Association, vol. 52(1), pages 35-55, March. [Downloadable!] (restricted)
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  5. Shleifer, Andrei & Vishny, Robert W, 1990. "Equilibrium Short Horizons of Investors and Firms," American Economic Review, American Economic Association, vol. 80(2), pages 148-53, May. [Downloadable!] (restricted)
  6. Hirshleifer, Jack, 1971. "The Private and Social Value of Information and the Reward to Inventive Activity," American Economic Review, American Economic Association, vol. 61(4), pages 561-74, September. [Downloadable!] (restricted)
  7. Kenneth A. Froot & David S. Scharfstein & Jeremy C. Stein, 1990. "Herd on the Street: Informational Inefficiencies in a Market with Short-Term Speculation," NBER Working Papers 3250, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Subrahmanyam, Avanidhar, 1998. "Transaction Taxes and Financial Market Equilibrium," Journal of Business, University of Chicago Press, vol. 71(1), pages 81-118, January. [Downloadable!] (restricted)
  9. Bruno Biais & Laurent Germain, 2002. "Incentive-Compatible Contracts for the Sale of Information," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 15(4), pages 987-1003.
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  11. Dow, James & Gorton, Gary, 1997. " Stock Market Efficiency and Economic Efficiency: Is There a Connection?," Journal of Finance, American Finance Association, vol. 52(3), pages 1087-1129, July. [Downloadable!] (restricted)
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  12. Holden, Craig W & Subrahmanyam, Avanidhar, 1996. "Risk Aversion, Liquidity, and Endogenous Short Horizons," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 9(2), pages 691-722. [Downloadable!] (restricted)
  13. Summers, L.H. & Summers, V.P., 1989. "When Financial Markets Work Too Well : A Cautious Case For A Securities Transactions Tax," Papers t12, Columbia - Center for Futures Markets.
  14. Holmstrom, Bengt & Tirole, Jean, 1993. "Market Liquidity and Performance Monitoring," Journal of Political Economy, University of Chicago Press, vol. 101(4), pages 678-709, August. [Downloadable!] (restricted)
  15. Stiglitz, J.E., 1989. "Using Tax Policy To Curb Speculative Short-Term Trading," Papers t2, Columbia - Center for Futures Markets.
  16. James Tobin, 1978. "A Proposal for International Monetary Reform," Cowles Foundation Discussion Papers 506, Cowles Foundation, Yale University. [Downloadable!]
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  17. Fishman, Michael J & Hagerty, Kathleen M, 1989. " Disclosure Decisions by Firms and the Competition for Price Efficienc y," Journal of Finance, American Finance Association, vol. 44(3), pages 633-46, July. [Downloadable!] (restricted)
  18. Dow, James & Gorton, Gary, 1994. " Arbitrage Chains," Journal of Finance, American Finance Association, vol. 49(3), pages 819-49, July. [Downloadable!] (restricted)
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  19. Fama, Eugene F, 1991. " Efficient Capital Markets: II," Journal of Finance, American Finance Association, vol. 46(5), pages 1575-617, December. [Downloadable!] (restricted)
  20. Rohit Rahi & James Dow, 1998. "Should Speculators be Taxed?," FMG Discussion Papers dp291, Financial Markets Group. [Downloadable!] (restricted)
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  21. John Y. Campbell & Kenneth A. Froot, 1993. "International Experiences with Securities Transaction Taxes," NBER Working Papers 4587, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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