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The Effect of a Transaction Tax on Exchange Rate VolatilityMarkku LanneUniversity of Helsinki - Department of Political and Economic Studies Timo VesalaUniversity 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 working papers seriesDate posted: October 3, 2007Suggested CitationContact Information
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