Transaction Taxes in a Price Maker/Taker Market
65 Pages Posted: 19 Mar 2010 Last revised: 11 Nov 2014
Date Written: November 10, 2014
We develop a price maker/taker model to study how a financial transaction tax affects markets where potential traders take a price or quote prices for the next potential trader. We find taxes widen quoted and effective spreads by many times the tax; significantly reduce asset prices, gains from quoting, gains from trade, and volume; and, do not eliminate destabilizing speculators. These effects are amplified in markets with intermediation. Volatility may decrease slightly without intermediation but increases significantly with intermediation. We find some early evidence of tax effects predicted by our model.
Keywords: transaction tax, Tobin tax, market microstructure, limit order model, market makers, high-frequency trading, search costs
JEL Classification: C72, D44, G19
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