Research Discussion Papers, Bank of Finland
No 11/2006:
The effect of a transaction tax on exchange rate volatility
Markku Lanne ()
and Timo Vesala
Abstract: We argue that a transaction tax is likely to amplify, not
dampen, volatility in the foreign exchange mar-kets. Our argument stems
from the decentralised trading practice and the presumable discrepancy
be-tween ‘informed’ and ‘uninformed’ traders’ valuations. Since informed
traders’ valuations are likely to be less dispersed, a transaction tax
penalises informed trades disproportionately, leading to increased
volatil-ity. 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
transac-tion costs is found to have a significant positive effect on
volatility.
Keywords: transaction tax; exchange rates; volatility; (follow links to similar papers)
JEL-Codes: F31; F42; G15; G28; (follow links to similar papers)
25 pages, October 10, 2006
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