Effect of Transaction Tax on the Relationship between Volatility and Trading Activities of Taiwan Stock Index Futures

Abstract

This paper examines the impact of the reduction of futures transaction taxes on the correlation between return volatility and trading activities of nearby contracts of the four stock index futures, i.e. TX futures, MTX futures, TE futures and TF futures on the Taiwan Futures Market. (The Taiwan futures transaction tax was lowered from 0.025% to 0.01% on January 1, 2006.) This paper considers the effects of time trends and seasonal factors on return volatility and trading activities by performing individual tests with Flexible Fourier Form (FFF) developed by Luu and Martens (2003). Meanwhile, this paper incorporates FFF into the two-equation structural model, which consists of the sum of intraday return volatility and trading volume (speculative trading activities) in order to test transaction taxes, time trends and seasonal effects. The research covers the period starting on July 1, 2004 through June 31, 2007. It performs an empirical analysis with daily and 5-minute intraday time series data. The result shows that there are variances in the effects of transaction taxes on the four futures. The trading volumes of TX futures, MTX futures and TE futures increased significantly after tax reductions; whereas the trading volume of TF futures fell markedly. This may be due to speculative trading activities. This paper also finds that after tax reductions, the speculative trading activities of these four futures dramatically picked up after tax cuts. Meanwhile, some studies indicate that the reduction of transaction taxes results in an increase in futures return volatility. Finally, we find that the trading activities of the four futures show time trends and seasonal effects.