The effect of a transaction tax on exchange rate volatility

Markku Lanne and Timo Vesala

No 11/2006, Bank of Finland Research Discussion Papers from Bank of Finland

Abstract: We argue that a transaction tax is likely to amplify, not dampen, volatility in the foreign exchange markets.Our argument stems from the decentralised trading practice and the presumable discrepancy between 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 volatility.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 transaction costs is found to have a significant positive effect on volatility.

Keywords: transaction tax; exchange rates; volatility (search for similar items in EconPapers)
JEL-codes: F31 F42 G15 G28 (search for similar items in EconPapers)
Date: 2006
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Related works:
Journal Article: The effect of a transaction tax on exchange rate volatility (2010)
Working Paper: The Effect of a Transaction Tax on Exchange Rate Volatility (2005)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bofrdp:rdp2006_011

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