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The Effect of a Transaction Tax on Exchange Rate Volatility


Markku Lanne


University of Helsinki - Department of Political and Economic Studies

Timo Vesala


University of Helsinki - Department of Political and Economic Studies

2006

Bank of Finland Research Discussion Paper No. 11/2006

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.

Number of Pages in PDF File: 25

Keywords: transaction tax, exchange rates, volatility

JEL Classification: F31, F42, G15, G28

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Date posted: October 3, 2007  

Suggested Citation

Lanne, Markku and Vesala, Timo, The Effect of a Transaction Tax on Exchange Rate Volatility (2006). Bank of Finland Research Discussion Paper No. 11/2006. Available at SSRN: http://ssrn.com/abstract=1018363 or http://dx.doi.org/10.2139/ssrn.1018363

Contact Information

Markku Lanne (Contact Author)
University of Helsinki - Department of Political and Economic Studies ( email )
P.O. Box 54
FIN-00014 Helsinki
Finland
+358-9-191 24626 (Phone)
+358-9-191 24780 (Fax)
Timo Vesala
University of Helsinki - Department of Political and Economic Studies ( email )
P.O. Box 54
FIN-00014 Helsinki
Finland
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