The relation between transaction tax and trading volume in KOSPI 200 futures market

Abstract

The current issue in the Korea Exchange (KRX) is newly proposed transaction tax on derivatives. The Korean derivatives market has been the most actively traded product in the world for many years. Politicians expect, although the trading volume can be decreased a little, it is acceptable for the revenue from a new source of tax. Transaction tax has not only volume effect but also influences volatility and economic welfare, so we will briefly cover that kind of issues in the early research section. This paper supports the argument that transaction taxes have a negative impact on trading volume. In the finance literature, the bid-ask spread is often considered as a cost of transaction. Using this relation, I will examine the elasticity between trading volume and bid-ask spread, and apply it to talk about the tax effect on the trading volume for Kospi 200 index futures. Generalized Method of Moments estimation was used to obtain a relation between trading volume and bid-ask spreads. Results indicate that there is an inverse relationship between trading volume and bid-ask spread, if 0.001% transaction tax is imposed on Kospi 200 index futures, the trading volume will be decreased by tiny percentage a year. Results from this study have important political implications. Our study indicate that a transaction tax on Kospi 200 index futures, which is analogous to a increased bid-ask spread, will reduce trading volume, but the reduction is not as great as some people expected.