The Role of Transaction Costs for Financial Volatility: Evidence from the Paris Bourse
Social Science Research Network
This paper analyzes the causal linkage between transaction costs and financial volatility under two methodological improvements over the existing literature. First, we use panel data in which exogenous transaction cost differences in the French stock market are induced by price level dependent minimum price variation rules (tick size rules). Unlike in previous studies based on one-time regulatory tick size changes (like the U.S. decimalization), we can separately identify and control for
... control for marketwide volatility changes. Second, we avoid the pitfalls of biased volatility measurement across regimes by using the range as a tick size robust volatility metric. Panel regressions controlling for marketwide volatility effects show at high levels of statistical significance that the hourly range volatility of individual stocks increases by more than 30% for a 20% exogenous increase in transaction costs due to tick size variations in the French trading system. In the light of this evidence, higher transaction costs in general, and security transaction taxes in particular, should be considered as volatility increasing. (JEL: F3, G1, G14) Acknowledgments: I thank seminar participants at INSEAD, Said Business School (Oxford), the Norwegian School of Management, the University of Oslo, and the University of Belfast for helpful comments.