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Myopic Traders, Efficiency and Taxation

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  • Alexander Gümbel

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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.

Suggested Citation

  • Alexander Gümbel, 2000. "Myopic Traders, Efficiency and Taxation," OFRC Working Papers Series 2000fe05, Oxford Financial Research Centre.
  • Handle: RePEc:sbs:wpsefe:2000fe05
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