The Role of Transaction Costs for Financial Volatility: Evidence from the Paris Bourse

Abstract

Minimum price variation rules (tick size rules) in the French stock market prior to 1999 provide a natural experiment on the role of transaction costs for financial price volatility. For stock prices above French francs (FF) 500, the minimal tick size for quotes increases from FF 0.1 to FF 1. This tick size increase generates a 20 percent higher median effective spread and therefore artificially inflates transaction costs. Using the range of the quoted midprice as a tick size robust volatility metric, we calculate 47,213 hourly volatility measures for all CAC40 stocks in the price range from FF 400 to FF 600 and measure the volatility impact of the transaction cost increase at FF 500. We find that the median hourly range volatility is approximately 16 percent higher in the high cost regime. Panel regressions confirm this result at a high level of statistical significance. In the light of this evidence, higher transaction costs in general, and security transaction taxes in particular, should be considered as volatility increasing.