This paper investigates the effect of transaction taxes in a multi-market setting. We develop an asymmetric information model in which informed and liquidity traders may trade in equity and derivative markets. We find that taxing stock markets has large effects on volume, while it can lead to positive effects on liquidity due to an alleviation of the adverse selection problem in the taxed market. When possible effects on market-making competition are included the effect on liquidity is ambiguous. Additionally, we find that options are generally less affected by taxation. We empirically test some of our model’s hypotheses with high-frequency data for Italy, France, and Spain on equity, derivative and OTC markets. We find evidence that supports our theoretical findings and sheds light on how different tax designs affect trading volume and liquidity across financial markets.
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