Tobin Tax and Exchange Rate Volatility: A Reassessment

Abstract

From Olsen Financial Studies data on the Euro-Dollar currency pair (2008-2010), we conduct a time-series analysis to explain the role of trading volume on exchange rate volatility (Mixture Distribution Hypothesis), taking into account non-linearity. We find evidence that the MDH holds in turbulent periods, during which spreads and volume trading are high. When spreads and the volume are high, the relationship between trading volume and volatility tends to increase. Linking this result with the Tobin tax debate implies that a Tobin tax would be effective for curbing speculation and reducing exchange rate volatility, even in turbulent periods. This paper provides the first empirical corroboration of this proposition and seems to confirm some previous theoretical papers in the vein of Tobin. All in all, two main results emerged. First, the abundant literature on the MDH, but exclusively based on linear econometrics, should take into account non-linearities. Second, the effect of a Tobin tax on volatility would be slightly context-dependent and always negative. A Tobin tax would have been stabilizing and effective in the 2008 crisis when spreads, volume and volatility were very high.