Sand in the Wheels or Wheels in the Sand? Tobin Taxes and Market Crashes
CERGE-EI Working Paper Series No. 511
44 Pages Posted: 30 Mar 2014
Date Written: March 1, 2014
The recent crisis revived interest in financial transaction taxes (FTTs) as a means to offset negative risk externalities. However, up-to-date academic research does not provide sufficient insights into the effects of transaction taxes on financial markets as the literature has here-to-fore been focused too narrowly on Gaussian variance as a measure of volatility. In this paper, we argue that it is imperative to understand the relationship between price jumps, Gaussian variance, and FTTs. While Gaussian variance is not necessarily a problem in itself, the non-normality of return distribution caused by price jumps affects not only the performance of many risk-hedging algorithms but directly influences the frequency of catastrophic market events. To study the aforementioned relationship, we use an agent-based model of financial markets. Its results show that FTTs may increase the variance while decreasing the impact of price jumps. This result implies that regulators may face a trade-off between overall variance and price jumps when designing optimal tax. However, the results are not robust to the size of the artificial market as non-linearities emerge when the size of the market is increased.
Keywords: price jumps, financial transaction taxes, agent-based modeling, Monte Carlo, volatility
JEL Classification: C15, C16, C61, G17, G18, H23
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