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Entry cost, the Tobin tax, and noise trading in the foreign exchange market

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  • Kang Shi
  • Juanyi Xu

Abstract

Two types of policy have been proposed to eliminate noise trading in the foreign exchange market: increasing the entry cost or imposing a ‘Tobin tax’ type of transaction tax. In this paper, we endogenize entry decisions of both informed traders and noise traders and show that these policies may be ineffective in reducing exchange rate volatility. This is because these policies will discourage the entry of all traders, so they may not change the relative ratio of traders, or they may affect informed traders disproportionately more, which increases the relative ratio of noise traders and exchange rate volatility. Deux types de politiques ont été proposées pour éliminer le bruit transactionnel qui empêche le prix d'être parfaitement révélateur dans le marché des changes : accroître le coût à l'entrée ou imposer une taxe à la Tobin sur les transactions. Dans ce texte, on endogénise les décisions à l'entrée à la fois des opérateurs informés et des autres qui n'ont pas d'information significative, et on montre que ces politiques sont ineffectives pour réduire la volatilité du taux de change. C'est que ces politiques découragent l'entrée de tous les opérateurs. En conséquence, elles peuvent ne pas changer le ratio des deux types d'opérateurs, ou peuvent même affecter les opérateurs informés davantage – ce qui accroît l'importance relative des moins informés et donc la volatilité du taux de change.

Suggested Citation

  • Kang Shi & Juanyi Xu, 2009. "Entry cost, the Tobin tax, and noise trading in the foreign exchange market," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 42(4), pages 1501-1526, November.
    • Handle: RePEc:wly:canjec:v:42:y:2009:i:4:p:1501-1526
    DOI: 10.1111/j.1540-5982.2009.01555.x
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    Cited by:

    1. Sirnes Espen, 2022. "Estimating the Effect of Transaction Costs Using the Tick Size as a Proxy," Review of Economics, De Gruyter, vol. 73(1), pages 57-77, April.
    2. Olivier Damette & St鰨ane Goutte, 2015. "Tobin tax and trading volume tightening: a reassessment," Applied Economics, Taylor & Francis Journals, vol. 47(29), pages 3124-3141, June.
    3. Damette, Olivier, 2016. "Mixture Distribution Hypothesis And The Impact Of A Tobin Tax On Exchange Rate Volatility: A Reassessment," Macroeconomic Dynamics, Cambridge University Press, vol. 20(6), pages 1600-1622, September.
    4. Olivier Damette & Beum-Jo Park, 2015. "Tobin Tax and Volatility: A Threshold Quantile Autoregressive Regression Framework," Review of International Economics, Wiley Blackwell, vol. 23(5), pages 996-1022, November.
    5. Bratis, Theodoros & Laopodis, Nikiforos T. & Kouretas, Georgios P., 2017. "Assessing the impact of an EU financial transactions tax on asset volatility: An event study," International Review of Financial Analysis, Elsevier, vol. 53(C), pages 12-24.
    6. Alonso, Miguel A. & Rallo, Juan Ramón & Romero, Alberto, 2013. "El efecto de los impuestos a las transacciones financieras en la estabilidad de los mercados de capital. Un debate sin resolver," El Trimestre Económico, Fondo de Cultura Económica, vol. 0(317), pages 207-231, enero-mar.
    7. Shin, Jong Kook & Singh, Rajesh & Subramanian, Chetan, 2014. "Monetary policy and Tobin taxes: a welfare analysis," ISU General Staff Papers 201403080800001035, Iowa State University, Department of Economics.
    8. Olivier Damette & Stéphane Goutte, 2014. "Tobin tax and trading volume tightening: a reassessment," Working Papers halshs-00926805, HAL.
    9. Chen, Haiwei, 2016. "A Tobin tax only on sellers," Finance Research Letters, Elsevier, vol. 19(C), pages 83-89.
    10. FitzGerald, John & Central Bank Staff, 2012. "The EU Financial Transactions Tax Proposal: A Preliminary Evaluation," Research Series, Economic and Social Research Institute (ESRI), number BKMNEXT217.

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    • F3 - International Economics - - International Finance
    • G1 - Financial Economics - - General Financial Markets

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