The Financial Transactions Tax in Markets with Adverse Selection

ECONOMICS & DECISION SCIENCES DEPARTMENT

Speaker : Peter Norman SORENSEN (University of Copenhagen)

HEC Campus - Building T - Room T004

Abstract :

I analyze theoretically how a financial transactions tax affects welfare in an imperfect market. Analysis of the benchmark Glosten-Milgrom model suggests two sets of results. First, the greater is the tax, the less liquid is the market, and the lower is total welfare. Second, realistic redistribution of the tax revenue lets uninformed, liquidity-motivated traders gain with the tax under a simple sufficient condition. This condition, that the tax reduces informed trading more than uninformed trading, can be easily verified in practice: the condition is that the half-spread respond less than one-for-one to tax changes.