One fundamental and two taxes: When does a Tobin tax reduce financial price volatility?

Yongheng Deng, Xin Liu*, Shang Jin Wei

*Corresponding author for this work

    Research output: Contribution to journalArticlepeer-review

    25 Citations (Scopus)

    Abstract

    We aim to make two contributions to the literature on the effects of transaction costs on financial price volatility. First, by augmenting a double differencing approach with a research design with three ingredients (a common set of companies simultaneously listed on two stock exchanges, binding capital controls, and different timing of changes in transaction costs), we obtain a control group that has identical corporate fundamentals as the treatment group. We apply the research design to Chinese stocks that are cross-listed in Hong Kong and Mainland China. Second, we allow transaction costs to have different effects in markets with different maturity. We find a significantly negative relationship, on average, between stamp duty increase and price volatility. However, this average effect masks some important heterogeneity. In particular, when institutional investors have become a significant part of the traders’ pool, we find an opposite effect. Overall, our results suggest that a Tobin tax could work in an immature market, but can backfire in a more developed market.

    Original languageEnglish
    Pages (from-to)663-692
    Number of pages30
    JournalJournal of Financial Economics
    Volume130
    Issue number3
    DOIs
    Publication statusPublished - Dec 2018

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