Securities Transaction Tax and Market Quality – the Case of France

• Author: Martin Haferkorn,Peter Gomber,Kai Zimmermann
• Published date: 01 March 2016
• DOI: http://doi.org/10.1111/eufm.12062
• Date: 01 March 2016

Securities Transaction Tax and Market

Quality –the Case of France

Peter Gomber, Martin Haferkorn and Kai Zimmermann

Goethe University Frankfurt, Frankfurt Faculty of Economics and Business Administration,

Gr€

uneburgweg 1, 60323 Frankfurt am Main, Germany

E-mail: Gomber/Haferkorn/Kzimmermann@wiwi.uni-frankfurt.de

Abstract

We study the French Securities Transaction Tax implementation of 1 August 2012.

Although a similar tax is planned to be introduced across 11 European countries,

consequences for market quality are yet to be thoroughly assessed. We show that

liquidity demand and supply significantly drop. Even though the French proposal

exempts professional liquidity provision, we find increased spreads and a declined

order book depth resulting in additional transaction costs for market participants

besides the tax. As all venues trading French stocks are affected, we further find that

STT threatens inter-market information transmission by impairing price

coordination among fragmented markets in Europe.

Keywords: financial transaction tax, liquidity, market efficiency, volatility

JEL classification: G12, G14, G18, G28

1. Introduction

The concept of the securities transaction tax (STT) is one of the most controversial topics

in financial markets regulation during the last four decades. Politicians argue that this tax

would dampen speculative trading activity leading to increased financial market integrity

(e.g. Summers and Summers, 1989; Stiglitz, 1989). Opponents posit that a STT would not

only impair financial markets’quality but also unnecessarily burden the economy by

biasing investors’capital allocation (e.g. Matheson, 2011; Habermeier and Kirilenko,

2001). Although theoretical research is widespread and supported by some empirical

We are grateful to John Doukas (the editor of this Journal) and the two anonymous referees

for their valuable comments. We thank the participants at the European Finance Association

Meeting (August 2013), the European Financial Management Association Annual

Conference (June 2013), E-Finance Lab Jour Fixe (July 2013) and the Southern Finance

Associating Annual Meeting (November 2013) for helpful comments and suggestions.

Correspondence: Peter Gomber

European Financial Management, Vol. 22, No. 2, 2016, 313–337

doi: 10.1111/eufm.12062

© 2015 John Wiley & Sons Ltd

studies, no common understanding on how a STT affects market quality is reached yet.

These scarce empirical results are limited in their applicability in today’s market settings

as conditions in recent years have changed drastically. In Europe, the ongoing

fragmentation process induced by the Markets in Financial Instruments Directive

(MiFID) fosters competition among trading venues. New technologies (e.g. high

frequency trading (HFT) as well as smart order routing) and innovative pricing regimes

like maker-taker pricing added even more layers of complexity. In the light of this

controversy, contradictory research results and the plans for a STT in many European

countries, research is crucial in providing guidance for regulators, practitioners and

academics alike.

In 2012, France decided to introduce a STT providing a suitable and recent case to draw

empirical conclusions on this subject. To follow the call of Schwert and Seguin (1993) to

provide more empirical evidence, we obtain insights into market quality changes via a

difference-in-differences analysis. First, by evaluating various dimensions of single-

market quality parameters, e.g. price volatility, trading activity and order book depth, we

will focus on STT induced changes to liquidity demand and supply at NYSE Euronext

Paris. We find trade executions (traded volumes) declining on average by 15 percent (19

percent) within 2 months (medium-term event window) after the implementation, which

is in line with results of previous studies like Pomeranets and Weaver (2012). Focusing on

order book liquidity provision, we find an instantaneous decline in order book depth

immediately after the introduction of the STT as well as a widening of the relative spread

levels although professional liquidity provision is not taxed, leading to additional implicit

transaction costs on top of the explicit tax. Although these effects are peaking in the short-

term event window (10 days after implementation), results remain robust even 6 month

after the implementation (long-term event window) and even after omitting the initial

peak. Market volatility levels remain unchanged in the long-, medium- as well as in the

short-term and therefore give no indication whether the lost order volume and trading

activity was of distinct disorienting nature, as argued by Summers and Summers (1989)

and Stiglitz (1989).

Second, in light of the fragmented nature of today’s European market landscape, we

add another dimension of market quality analysis. As French stocks are traded on multiple

trading venues, we analyse whether the quality of inter-market price coordination

among French stocks has changed after the STT introduction. Information transmission

between dispersed markets is a major requirement for price coordination, thereby

ensuring price homogeneity and investors’confidence among fragmented markets

(Hasbrouck, 1995). By investigating information transmission between two taxed

markets before and after the STT, we give an insight how this coordination mechanism

is affected by the STT following the methodology of Engle and Granger (1987). We

find that price coordination between venues deteriorates significantly, as exogenous

shocks to the long-term price equilibrium are reverted slower than before the introduction

of the tax.

Our paper is structured as follows: In the next section we present a literature review on

transaction taxes in general. We then provide a systematic insight on the French STT

outlining relevant characteristics. In the research design section, we exhibit our dataset

and methodology. The results related to market quality and inter-market information

transmission as well as a review of the results of recent other papers on the impact of the

French STT are presented in sections 5 and 6 respectively. Concluding remarks and

outlook are given in the last section.

© 2015 John Wiley & Sons Ltd

314 Peter Gomber, Martin Haferkorn and Kai Zimmermann