On the non-homogeneous effect of financial transaction taxes

Abstract

This paper investigates the impact of a financial transaction tax (FTT) in a classic financial market setting. The benchmark analysis is based on an extension of the model presented in Kyle (1985). Opposed to the existing literature, I am able to find equilibrium values with a linear tax. Results of the benchmark model confirm standard findings of FTT’s, such as an increased bidask spread and an overall less deep market. Importantly, I find that the introduction of a tax leads to a non-linear pricing function. In turn, the model predicts a decrease in market depth and trading aggressiveness for small trades, whereas for larger trades the introduction of a FTT only leads to increased spreads and prices.