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Transaction Taxes, Traders?Behavior and Exchange Rate Risks

  • Markus Demary
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    We propose a new model of chartist-fundamentalist-interaction in which both groups of traders are allowed to select endogenously between different forecasting models and different investment horizons. Stochastic interest rates in both countries and different behavioral assumptions for trend-extrapolating and fundamental based forecasts determine the agents? market orders which drive the exchange rate. A numerical analysis of the model shows that it is able to replicate stylized facts of observed financial return time series like excess kurtosis and volatility clustering. Within this framework we study the effects of transaction taxes on exchange rate volatil- ity and traders? behavior measured by their population fractions. Simula- tions yield the result that on the macroscopic level these taxes reduce the variance of exchange rate returns, but also increase their kurtosis. Moreover, on the microscopic level the tax harms short-term speculation in favor of long-term investment, while it also harms trading rules based on economic fundamentals in favor to trend extrapolating trading rules.

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    File URL: http://www2.warwick.ac.uk/fac/soc/wbs/research/wfri/rsrchcentres/ferc/wrkingpaprseries/fwp06-13.pdf
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    Paper provided by Warwick Business School, Finance Group in its series Working Papers with number wp06-13.

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    Date of creation: 2006
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    Handle: RePEc:wbs:wpaper:wp06-13
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    1. Frank Westerhoff, 2003. "Heterogeneous traders and the Tobin tax," Journal of Evolutionary Economics, Springer, vol. 13(1), pages 53-70, 02.
    2. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
    3. Engel, Charles & Hamilton, James D, 1990. "Long Swings in the Dollar: Are They in the Data and Do Markets Know It?," American Economic Review, American Economic Association, vol. 80(4), pages 689-713, September.
    4. Menkhoff, Lukas, 1997. "Examining the Use of Technical Currency Analysis," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 2(4), pages 307-18, October.
    5. Taylor, Mark P. & Allen, Helen, 1992. "The use of technical analysis in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 11(3), pages 304-314, June.
    6. repec:att:wimass:9506 is not listed on IDEAS
    7. Tim Bollerslev, 1986. "Generalized autoregressive conditional heteroskedasticity," EERI Research Paper Series EERI RP 1986/01, Economics and Econometrics Research Institute (EERI), Brussels.
    8. William A. Brock & Cars H. Hommes, 1995. "Rational Routes to Randomness," Working Papers 95-03-029, Santa Fe Institute.
    9. Carl Chiarella & Tony He, 2002. "An Adaptive Model on Asset Pricing and Wealth Dynamics with Heterogeneous Trading Strategies," Computing in Economics and Finance 2002 135, Society for Computational Economics.
    10. Lux, T. & M. Marchesi, . "Volatility Clustering in Financial Markets: A Micro-Simulation of Interacting Agents," Discussion Paper Serie B 437, University of Bonn, Germany, revised Jul 1998.
    11. De Grauwe, Paul & Grimaldi, Marianna, 2006. "Exchange rate puzzles: A tale of switching attractors," European Economic Review, Elsevier, vol. 50(1), pages 1-33, January.
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