Transaction Taxes and Financial Market Equilibrium
Posted: 30 Nov 1995
Date Written: Undated
We explore the effects of transaction taxes in financial markets with asymmetric information. We show that transaction taxes cause competing informed traders to scale back their aggregate trading towards the quantity traded by a monopolist informed trader. Surprisingly, this causes both market liquidity and informed investor profits to decline in the level of the transaction tax. We also analyze the effect of a transaction tax on the welfare of risk averse, informed hedgers. In the context of a dynamic, competitive model in which agents expend scarce resources to influence early receipt of an information signal, we find that transaction taxes generally cause the proportion of informed agents who choose to acquire information early to decline. Thus, our analysis suggests that transaction taxes can have the beneficial effect of reducing wasteful rent seeking in the "race" to obtain information early. We also show that transaction taxes can reduce (increase) the equilibrium proportion of agents who are short-term (long-term) oriented in their information acquisition decisions, and thus can enhance long-term informational efficiency and resource allocation.
JEL Classification: G1, G2, D8, K2
Suggested Citation: Suggested Citation