Stock price volatility, transactions costs and securities transactions taxes

Securities Transactions Taxes (STTs) are intended to reduce or eliminate excessive volatility in stock prices caused by short-term speculative trading. To examine the implicit assumption that stock price volatility is caused by short-term trading, we investigate the relationship between volatility and bid-ask spreads, since short-term speculative traders and other investors with short time horizons will prefer stocks with low transactions costs. Our finding, that volatility is actually associated with high transactions costs, is inconsistent with the ‘speculator’ story. Our study suggests that the effect of an STT may be to impede the adjustment of stock prices to new information, rather than to curb ‘excessive short-term speculation’.