Transaction taxes in a price maker/taker market

Rosenthal, Dale W.R. and Thomas, Nordia Diana Marie (2012): Transaction taxes in a price maker/taker market.

Abstract

We develop a price maker/taker model to study how a financial transaction tax affects markets. We find taxes widen quoted and effective spreads by more than twice the tax. Taxes increase volatility slightly (without intermediation) to significantly (with intermediation). High taxes may halve volumes and gains from trade while doubling search costs. Measures of market quality are more affected by taxes in markets with intermediaries. Investors and intermediaries competing for liquidity can triple search costs and increase quoted spreads while decreasing effective spreads. We also find revenue-optimal rates of 60-75 bp. Our results are particularly relevant to markets with high-frequency trading or thin depth.

• Item Type: MPRA Paper
• Language: English
• Keywords: transaction tax, Tobin tax, market microstructure, limit order model, high-frequency trading, search costs
• Subjects: D - Microeconomics > D4 - Market Structure, Pricing, and Design > D44 - Auctions; G - Financial Economics > G1 - General Financial Markets > G18 - Government Policy and Regulation; C - Mathematical and Quantitative Methods > C7 - Game Theory and Bargaining Theory > C72 - Noncooperative Games

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