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One fundamental and two taxes: When does a Tobin tax reduce financial price volatility?

Yongheng Deng (), Xin Liu and Shang-Jin Wei

Journal of Financial Economics, 2018, vol. 130, issue 3, 663-692

Abstract: We aim to make two contributions to the literature on the effects of transaction costs on financial price volatility. First, by augmenting a double differencing approach with a research design with three ingredients (a common set of companies simultaneously listed on two stock exchanges, binding capital controls, and different timing of changes in transaction costs), we obtain a control group that has identical corporate fundamentals as the treatment group. We apply the research design to Chinese stocks that are cross-listed in Hong Kong and Mainland China. Second, we allow transaction costs to have different effects in markets with different maturity. We find a significantly negative relationship, on average, between stamp duty increase and price volatility. However, this average effect masks some important heterogeneity. In particular, when institutional investors have become a significant part of the traders’ pool, we find an opposite effect. Overall, our results suggest that a Tobin tax could work in an immature market, but can backfire in a more developed market.

Keywords: Tobin tax; Transaction cost; Volatility; Speculation; Limits to arbitrage (search for similar items in EconPapers)
JEL-codes: G12 G14 G15 G18 (search for similar items in EconPapers)
Date: 2018
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Working Paper: One Fundamental and Two Taxes: When Does a Tobin Tax Reduce Financial Price Volatility? (2014) Downloads
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Handle: RePEc:eee:jfinec:v:130:y:2018:i:3:p:663-692