Effects of securities transaction taxes on depth and bid-ask spread

Abstract

This note investigates the effects of introducing a transaction tax on depth and bid-ask spread using a static model where a competitive market maker faces informed and liquidity traders. When the degree of information asymmetry is low, an increase in the transaction tax can result into a smaller rise in the selling price and the depth may even increase in some cases.When information asymmetry is high, the dealer could increase the selling price more than the tax and sometimes lowers the depth. This can result in a market shutdown if the liquidity trader is driven out of the market.