Abstract
We quantify the effects of financial regulation in an equilibrium model with delegated portfolio management. Fund managers trade stocks and bonds in an order-driven market, subject to transaction taxes and constraints on short-selling and leverage. Results are obtained on the equilibrium properties of portfolio choice, trading activity, market quality and price dynamics under the different regulations. We find that these measures are neither as beneficial as some politicians believe nor as damaging as many practitioners fear.
Highlights
IntroductionSince the 2008 crisis, financial transaction taxes and bans on short selling have seen strong political support
Regulatory reform of capital markets is high on policy makers’ agenda
Our paper introduces a new methodology to quantify the effects of regulatory reform in an equilibrium model with market microstructure
Summary
Since the 2008 crisis, financial transaction taxes and bans on short selling have seen strong political support. More than 30 countries implemented short-selling bans in 2008, and the dominant member states of the European Union are determined to impose a financial transaction tax on all market participants, including financial intermediaries. Policy makers praise both measures for their ability to stabilize markets. In contrast, claim that these regulations reduce liquidity and increase the cost of capital. While the finance literature emphasizes the impact of regulation on liquidity, price discovery and volatility, economists tend to be more concerned with speculative trading and excessive risk-taking. We attempt to bridge the gap by integrating trading and portfolio management in a numerical model with market microstructure and heterogeneous agents. The goal is to provide
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