Effects of Securities Transaction Taxes on Depth and Bid-Ask Spread

Dominique Y. Dupont and Gabriel Lee
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Dominique Y. Dupont: University of Twente, School of Management and Technology, Department of Finance and Accounting

No 132, Economics Series from Institute for Advanced Studies

Abstract: This paper investigates the effects of transaction taxes on depth and bid-ask spread under asymmetric information. The paper uses a static model where a monopolistic market maker faces liquidity and informed traders. Introducing transaction taxes could, surprisingly, lead to increase in depth. Under some distributional assumptions, when market conditions are favorable to the dealer, the spread responds less than proportionally to an increase in the transaction tax while the depth actually increases. In contrast, when market conditions are unfavorable to the dealer, the spread widens more than proportionally and the depth decreases, potentially to zero, in response to an increase in the transaction tax. Our model sheds light on the disagreement in the empirical literature on the relative magnitude of transaction costs on trading volume.

Keywords: Asymmetric information; Securities transaction taxes; Liquidity (search for similar items in EconPapers)
JEL-codes: D82 G14 (search for similar items in EconPapers)
Pages: 17 pages
Date: 2003-05
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https://irihs.ihs.ac.at/id/eprint/1493 First version, 2003 (application/pdf)

Related works:
Journal Article: Effects of Securities Transaction Taxes on Depth and Bid-Ask Spread (2007)
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