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The effect of a transaction tax on exchange rate volatility
Author(s) -
Lanne Markku,
Vesala Timo
Publication year - 2010
Publication title -
international journal of finance and economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.505
H-Index - 39
eISSN - 1099-1158
pISSN - 1076-9307
DOI - 10.1002/ijfe.399
Subject(s) - volatility (finance) , economics , database transaction , transaction cost , monetary economics , foreign exchange , econometrics , financial economics , microeconomics , computer science , programming language
We argue that a transaction tax is likely to amplify, not dampen, volatility in foreign exchange markets. Our argument stems from the decentralized trading practice and the presumable discrepancy between ‘informed’ and ‘uninformed’ traders' valuations. Given that the informed valuations are likely to be less dispersed, a transaction tax penalizes 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. Copyright © 2009 John Wiley & Sons, Ltd.