Can a financial transaction tax prevent stock price booms?

Abstract

We present a stock market model that quantitatively replicates the joint behavior of stock prices, trading volume and investor expectations. Stock prices in the model occasionally display belief-driven boom and bust cycles that delink asset prices from fundamentals and redistribute considerable amounts of wealth from less to more experienced investors. Although gains from trade arise only from subjective belief di¤erences, introducing …nancial transactions taxes (FTTs) remains undesirable. While FTTs reduce the size and length of boom-bust cycles, they increase the likelihood of such cycles, therby overall return volatility and wealth redistribution. Contingent FTTs, which are levied only above a certain price threshold, give rise to problems of equilibrium multiplicity and non-existence.

Stock Price Booms and Expected Capital Gains

“…Table 9 reports the expected discounted utility of agents that use current and lagged belief updating for different values of α and for the two considered selection rules. 96 It shows that independently of the selection rule and independently of the share of current updaters α , utility of lagged updaters always exceeds that of current 93 This finding is in line with results reported in Adam et al (2015), who show that agents whose beliefs are more reactive to price growth observations tend to do worse than agents whose beliefs display less sensitivity. 94 Updaters using current price information update beliefs according to equation (39), but replace ln P t−1 /ln P t−2 by ln P t /ln P t−1 on the right-hand side.…”

“…In deriving our results, we assumed that all agents in the economy become more (or less) optimistic when observing capital gains above (or below) their expectations. While the quantitative model predictions survive when investors are heterogeneous in the degree to which they respond to observed capital gains (see Adam et al 2015), it appears of interest to assess the potential price impact generated by speculators with rational price expectations. While rational speculators can contribute to price destabilization, as in De Long et al (1990), they may also help with price stabilization, as in Barberis et al (2015).…”

“…robustness of our quantitative results toward allowing for investor heterogeneity. Adam et al (2015) explore in greater detail a heterogeneous agent version of the present model and show that the model successfully matches important stylized facts regarding trading volume.…”

Does Financial Tranquility Call for More Stringent Regulation?

“…Our results also apply if we use financial transaction tax instead. For discussions of the financial transaction tax, see Adam et al (2015).…”

“…The famous admission of Greenspan (2008) that he had "made a mistake in presuming that the self-interest of organisations, specifically banks, is such that they were best capable of protecting shareholders and equity in the firms" was an ex post acknowledgement that regulators had overestimated the resilence of the financial system in the run-up to the crisis. 7 An example of such an industry is the rapidly growing online finance industry in China. As reported by the Financial Times on March 20, 2017, China's digital payments market has exploded to about 50 times the size of that in the United States.…”