Effects of Securities Transaction Taxes on Depth and Bid-Ask Spread

Subir Chattopadhyay · Others Poor · Baldev Raj · Franz Breuer · Jo Reichertz · Gabriel S. Lee +2 more

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Financial Markets and Investment Strategies Economic and Fiscal Studies Stochastic processes and financial applications

Abstract

This note investigates the effects of introducing a transaction tax on depth and bid-ask spread using a static model where a competitive market maker faces informed and liquidity traders. When the degree of information asymmetry is low, an increase in the transaction tax can result into a smaller rise in the selling price and the depth may even increase in some cases. When information asymmetry is high, the dealer could increase the selling price more than the tax and sometimes lowers the depth. This can result in a market shutdown if the liquidity trader is driven out of the market.

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References

1985Continuous Auctions and Insider Trading 1985Bid, ask and transaction prices in a specialist market with heterogeneously informed traders 1998Alternative factor specifications, security characteristics, and the cross-section of expected stock returns1We are especially grateful to Eugene Fama (a referee), an anonymous referee and Bill Schwert (the editor) for insightful and constructive suggestions. We also thank Wayne Ferson, Ken French, Will Goetzmann, Craig Holden, Ravi Jagannathan, Bob Jennings, Bruce Lehmann, Josef Lakonishok, Richard Roll, participants at the 1997 Meetings of the Western Finance Association, the 1997 UCLA/USC/UC Irvine conference, the November 1997 Asset Pricing Meeting of the National Bureau of Economic Research, the Atlanta Forum, and seminars at Columbia, Indiana, Florida, New York, Tulane, and Yale Universities; Eugene Fama and Ken French for providing part of the data used in this study; and Christoph Schenzler for excellent programming assistance. The second author acknowledges support from the Dean's Fund for Research and the Financial Markets Research Center at Vanderbilt University. We are responsible for remaining errors. This paper was formerly titled `A Re-Examination of Security Return Anomalies'.1 1986Capital Market Equilibrium with Transaction Costs 1998Transaction Costs and Asset Prices: A Dynamic Equilibrium model 1994The Effect of Market Segmentation and Illiquidity on Asset Prices: Evidence from Exchange Listings 1999Equilibrium interest rate and liquidity premium with transaction costs 1998Transaction Taxes and Financial Market Equilibrium

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