Tobin tax and trading volume tightening: a reassessment

This article extends the previous literature on the Tobin tax and financial transaction
tax. We investigate the linkages between trading volumes and transaction costs using both a
linear and a nonlinear methodology. In stark contrast with previous studies, we consider the
possibility that our model may exhibit threshold effects or regime dependency by estimating
a Markov Switching (MS) model. This paper is the first contribution to specify the trading
volume of the Forex through different (low and high volatility) regimes. Our empirical
investigation looks at the EUR/USD currency market. Our results show evidence of nonlinear
patterns for trading volumes and transaction costs on the Forex. The Tobin tax would not
have a monotonic impact on trading activity across market conditions. However, the change
in elasticity between low and high volatility regimes is slight (-0.17 versus -0.21). We may
suggest that the low-variance regime might be the fundamentalist regime and the high-
variance regime (lower Tobin tax elasticity) might be the chartist regime. This study is a
first step towards understanding which categories of agents dominate the market under the
various market regimes and how they would react to the introduction of a tax. This means
our results are consistent with Tobin’s underlying thinking (1974, 1978, 1996). Since a tax
would penalize chartists more than fundamentalists, it could reduce exchange rate volatility.