Question

If a tax were put on stock market transactions, it would probably substantially reduce trading. What would you expect it to do to volatility of individual stocks and stock indices?

Please link any articles you have used to help you answer this question.

Answer 1

If a tax were put on stock market transactions, it would increase the transaction cost of trading activity and hence reduce the volatility of the individual stocks and stock indices. The reason behind is simple, each transaction will bear an extra cost of tax and hence the investor would go for transaction only when bearing the extra cost is justified, as the expected return from the transaction does not come with 100% surety but this cost will happen irrespective of what outcome is achieved.

In other words, if it's hard to trade, prices won't move very much because there will be fewer trades and fewer opportunities to mark the stocks to market. If it's cheaper (no tax) to trade, prices will fluctuate freely and it will be less expensive for speculators to participate.

Please link any articles you have used to help you answer this question: I am answering this question from my knowledge gained during my MBA and the CFA program curriculum.