DP10727 Can a Financial Transaction Tax Prevent Stock Price Booms?

Author(s): Klaus Adam, Johannes Beutel, Albert Marcet, Sebastian Merkel
Publication Date: July 2015
Keyword(s): asset price booms, financial transactions tax, Tobin tax
JEL(s): D84, G12
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10727

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 differences, introducing financial 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.