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118-619: Tobin suggested his currency transaction tax in 1972 in his Janeway Lectures at Princeton , shortly after the Bretton Woods system of monetary management ended in 1971. Prior to 1971, one of the chief features of the Bretton Woods system was an obligation for each country to adopt a monetary policy that maintained the exchange rate of its currency within a fixed value—plus or minus one percent—in terms of gold . Then, on August 15, 1971, United States President Richard Nixon announced that

236-523: A currency transaction tax was to find a way to manage exchange-rate volatility. In his view, "currency exchanges transmit disturbances originating in international financial markets. National economies and national governments are not capable of adjusting to massive movements of funds across the foreign exchanges, without real hardship and without significant sacrifice of the objectives of national economic policy with respect to employment, output, and inflation." Tobin saw two solutions to this issue. The first

354-419: A "dramatic 70% increase in equity turnover". Analyzing all three Stamp Duty rate changes, Saporta and Kan (1997) found that the announcements of tax rate increases (decreases) were followed by negative (positive) returns, but even though these results were statistically significant, they were likely to be influenced by other factors, because the announcements were made on Budget Days . Bond et al. (2005) confirmed

472-642: A "tax on speculation". On the other hand, as much as 40% of the Stamp Duty revenues come from taxing foreign residents, because the tax is "chargeable whether the transaction takes place in the UK or overseas, and whether either party is resident in the UK or not." In 2005, the Tobin tax was developed into a modern proposal by the United Kingdom NGO Stamp Out Poverty. It simplified the two-tier tax in favour of

590-518: A 1% tax. In July 1986 the rate was doubled. In January 1989, a considerably lower tax of 0.002% on fixed-income securities was introduced for a security with a maturity of 90 days or less. On a bond with a maturity of five years or more, the tax was 0.003%. The revenues from taxes were disappointing; for example, revenues from the tax on fixed-income securities were initially expected to amount to 1,500 million Swedish kronor per year. They did not amount to more than 80 million Swedish kronor in any year and

708-703: A European Union Tobin tax to base the communities' financial structure on more stable and independent grounds. However, the proposal was rejected by the European Commission . On November 23, 2009, the President of the European Council , Herman Van Rompuy , after attending a meeting of the Bilderberg Group argued for a European version of the Tobin tax. This tax would go beyond just financial transactions: "all shopping and petrol would be taxed.". Countering him

826-494: A European Union Tobin tax which he thought would base the community's financial structure on more stable and independent grounds. However, the proposal was rejected by the European Commission. On September 19, 2001, retired speculator George Soros put forward a proposal, special drawing rights or SDRs that the rich countries would pledge for the purpose of providing international assistance, without necessarily dismissing

944-708: A Tobin tax in a communiqué sent to the International Monetary Fund . For supporters of a Tobin tax, there is a wide range of opinion on who should administer a global Tobin tax and what the revenue should be used for. There are some who think that it should take the form of an insurance: In early November 2009, at the G20 finance ministers summit in Scotland, the British Prime Minister " Mr. Brown and Nicolas Sarkozy , France's president, suggested that revenues from

1062-407: A bond, a yield curve of similar zero-coupon bonds with different maturities is created. If the curve were to be created with Treasury securities of different maturities, they would be stripped of their coupon payments through bootstrapping. This is to transform the bonds into zero-coupon bonds. The yield of these zero-coupon bonds would then be plotted on a diagram with time on the x -axis and yield on

1180-651: A car purchased in the United States is cheaper than the same car in Canada. Canadians would buy their cars across the border to exploit the arbitrage condition. At the same time, Americans would buy US cars, transport them across the border, then sell them in Canada. Canadians would have to buy American dollars to buy the cars and Americans would have to sell the Canadian dollars they received in exchange. Both actions would increase demand for US dollars and supply of Canadian dollars. As

1298-506: A consideration of different exchange rates to recognise the most profitable places of issuance and settlement for a bill of exchange (" L'arbitrage est une combinaison que l’on fait de plusieurs changes, pour connoitre [ connaître , in modern spelling] quelle place est plus avantageuse pour tirer et remettre ".) If the market prices do not allow for profitable arbitrage, the prices are said to constitute an arbitrage equilibrium , or an arbitrage-free market. An arbitrage equilibrium

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1416-409: A country’s central bank buys and sells its own currency on international markets to keep its value relatively stable. The bank buys back its currency when a ‘glut’ caused by an investor selloff threatens to reduce the currency's value. In the past, most central banks had enough cash in reserve to offset any selloff or ‘attack’. However, this is no longer the case. Speculators now have more cash than all

1534-477: A currency or derivative). In academic use, an arbitrage involves taking advantage of differences in price of a single asset or identical cash-flows; in common use, it is also used to refer to differences between similar assets ( relative value or convergence trades ), as in merger arbitrage . The term is mainly applied in the financial field. People who engage in arbitrage are called arbitrageurs ( / ˌ ɑːr b ɪ t r ɑː ˈ ʒ ɜːr / ). Arbitrage has

1652-419: A day), banks were perfectly positioned to participate. Among swap transactions , which represented a major chunk of the foreign exchange market, 86 per cent of the transactions were actually between banks." A representative of a “pro Tobin tax” NGO argued as follows: "[The Tobin tax] is designed to reduce the power financial markets have to determine the economic policies of national governments. Traditionally,

1770-505: A factor in the "risk fee". Critics of all financial transaction taxes and currency transaction taxes emphasize the financial risk management difficulty of differentiating hedging from speculation , and the economic argument (attributed to the "Chicago School") that they cannot in principle be differentiated. However, advocates of such taxes considered these problems manageable, especially in context of broader financial transaction tax . James Tobin's purpose in developing his idea of

1888-431: A fee based on their size and their risk of contributing to another crisis." The calculations of such fees would necessarily depend on financial risk management criteria (see Basel II and Basel III ). Because of its restriction to so-called "harmful high-frequency trading" rather than to inter-currency transactions, neither of Clinton's proposals could be considered a true Tobin tax though international exposure would be

2006-619: A financial crisis, often termed a " flight to quality "; these are precisely the times when it is hardest for leveraged investors to raise capital (due to overall capital constraints), and thus they will lack capital precisely when they need it most. Grey market arbitrage is the sale of goods purchased through informal channels to earn the difference in price. Excessive gray market arbitrage will lead to arbitrage behaviors in formal channels, which will reduce returns due to factors such as price confusion, and may even cause prices to plummet in severe cases. Also known as geographical arbitrage , this

2124-505: A general currency transaction tax , a more general financial transaction tax and (the most general) Robin Hood tax on transactions only richer investors can afford to engage in. A key issue with Tobin's tax was "avoidance by change of product mix... market participants would have an incentive to substitute out of financial instruments subject to the tax and into instruments not subject to it. In this fashion, markets would innovate so as to avoid

2242-561: A group of eleven states began pursuing the idea of utilizing enhanced co-operation to implement the tax in states which wish to participate. Opinion polls indicate that 41 percent of the British people are in favour of some forms of FTT (see section: Public opinion ). The proposal supported by the eleven EU member states , was approved in the European Parliament in December 2012, and by

2360-525: A large loss as they can capture a higher after-tax yield by offsetting the taxable corporate income with underwriting losses). There are additional inefficiencies arising from the highly fragmented nature of the municipal bond market which has two million outstanding issues and 50,000 issuers, in contrast to the Treasury market which has 400 issues and a single issuer. Second, managers construct leveraged portfolios of AAA- or AA-rated tax-exempt municipal bonds with

2478-488: A mechanism designed solely as a means for raising development revenue. The currency market by this time had grown to $ 2,000 billion a day. To investigate the feasibility of such a tax they hired the City of London firm Intelligence Capital, who found that a tax on the pound sterling wherever it was traded in the world, as opposed to a tax on all currencies traded in the UK, was indeed feasible and could be unilaterally implemented by

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2596-578: A national level. In July, 2006, analyst Marion G. Wrobel examined the international experiences of various countries with financial transaction taxes. The EU financial transaction tax (EU FTT) is a proposal made by the European Commission in September 2011 to introduce a financial transaction tax within the 27 member states of the European Union by 2014. The tax would only impact financial transactions between financial institutions charging 0.1% against

2714-449: A piggyback. The latter would be dormant in times of normal financial activities, and be activated only in the case of speculative attacks. The mechanism allowing the identification of abnormal trading in world financial markets would make reference to a "crawling peg" with an appropriate exchange rate band. The exchange rate would move freely within this band without transactions being taxed. Only transactions effected at exchange rates outside

2832-619: A positive cash flow in at least one state; in simple terms, it is the possibility of a risk-free profit after transaction costs. For example, an arbitrage opportunity is present when there is the possibility to instantaneously buy something for a low price and sell it for a higher price. In principle and in academic use, an arbitrage is risk-free; in common use, as in statistical arbitrage , it may refer to expected profit, though losses may occur, and in practice, there are always risks in arbitrage, some minor (such as fluctuation of prices decreasing profit margins), some major (such as devaluation of

2950-583: A result, there would be an appreciation of the US currency. This would make US cars more expensive and Canadian cars less so until their prices were similar. On a larger scale, international arbitrage opportunities in commodities, goods, securities , and currencies tend to change exchange rates until the purchasing power is equal. In reality, most assets exhibit some difference between countries. These, transaction costs , taxes, and other costs provide an impediment to this kind of arbitrage. Similarly, arbitrage affects

3068-570: A resurgence in the discussion on reforming the international financial system. In addition to many legislative initiatives in favour of the Tobin tax in national parliaments, possible ways to introduce a Tobin-style currency transaction tax (CTT) are being scrutinised by the United Nations. European Union leaders urged the International Monetary Fund on Friday to consider a global tax on financial transactions in spite of opposition from

3186-453: A small amount closer (but often no closer than 0), while they can get very far apart. The day-to-day risks are generally small because the transactions involve small differences in price, so an execution failure will generally cause a small loss (unless the trade is very big or the price moves rapidly). The rare case risks are extremely high because these small price differences are converted to large profits via leverage (borrowed money), and in

3304-410: A specific currency transaction tax (CTT) in the manner of Tobin's original idea, and other times it has been used interchangeably with the various different ideas of a more general financial transaction tax (FTT). In both cases, the various ideas proposed have included both national and multinational concepts. Examples of associating Tobin's tax with these: The concept of a Tobin tax has experienced

3422-489: A system include an international charge on foreign-exchange transactions. In 2001, in another context, just after "the 90s' crises in Mexico, Southeast Asia and Russia," which included the 1994 economic crisis in Mexico , the 1997 Asian Financial Crisis , and the 1998 Russian financial crisis , Tobin summarized his idea: The tax on foreign exchange transactions was devised to cushion exchange rate fluctuations . The idea

3540-409: A tax on harmful high-frequency trading and reform rules to make our stock markets fairer, more open, and transparent.". However, the term "high-frequency" implied that only a few large volume transaction players engaged in arbitrage would likely be affected. Clinton referred separately to "Impose a risk fee on the largest financial institutions. Big banks and financial companies would be required to pay

3658-516: Is Stamp Duty Reserve Tax (SDRT) and stamp duty . Stamp duty was introduced as an ad valorem tax on share purchases in 1808, preceding by over 150 years the Tobin tax on currency transactions. Changes were made in 1963. In 1963 the rate of the UK Stamp Duty was 2%, subsequently fluctuating between 1% and 2%, until a process of its gradual reduction started in 1984, when the rate was halved, first from 2% to 1%, and then once again in 1986 from 1% to

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3776-458: Is a measure of market efficiency. Arbitrage tends to reduce price discrimination by encouraging people to buy an item where the price is low and resell it where the price is high (as long as the buyers are not prohibited from reselling and the transaction costs of buying, holding, and reselling are small, relative to the difference in prices in the different markets). Arbitrage moves different currencies toward purchasing power parity . Assume that

3894-404: Is a precondition for a general economic equilibrium . The "no arbitrage" assumption is used in quantitative finance to calculate a unique risk neutral price for derivatives . Arbitrage-free pricing for bonds is the method of valuing a coupon-bearing financial instrument by discounting its future cash flows by multiple discount rates. By doing so, a more accurate price can be obtained than if

4012-432: Is bigger in scope, and pushes the design toward a generalized securities transaction tax that resembles the tax suggested by Pollin et al. (1999). There are four benefits to this. First, it is likely to generate significantly greater revenues. Second, it maintains a level playing field across financial markets so that no individual financial instrument is arbitrarily put at a competitive disadvantage versus another. Third, it

4130-431: Is generally possible only with securities and financial products that can be traded electronically, and even then, when each leg of the trade is executed, the prices in the market may have moved. Missing one of the legs of the trade (and subsequently having to trade it soon after at a worse price) is called 'execution risk' or more specifically 'leg risk'. In the simplest example, any good sold in one market should sell for

4248-415: Is likely to enhance domestic financial market stability by discouraging domestic asset speculation. Fourth, to the extent that advanced economies already put too many real resources into financial dealings, it would cut back on this resource use, freeing these resources for other productive uses [Fourth] such substitution is costly both in resource use, and because alternative instruments do not provide exactly

4366-460: Is not viable and should be laid aside for good." On September 19, 2001, retired speculator George Soros put forward a proposal based on the IMF 's existing special drawing rights (SDRs) mechanism. In Soros' scheme, rich countries would pledge SDRs (which are denominated as a basket of multiple 'hard' currencies) for the purpose of providing international assistance. Soros was not necessarily dismissing

4484-415: Is often disastrous for a national economy, as the nineties' crises in Mexico, Southeast Asia and Russia have proven. My tax would return some margin of manoeuvre to issuing banks in small countries and would be a measure of opposition to the dictate of the financial markets . Though James Tobin suggested the rate as 0.5%, in that interview setting, others have tried to be more precise in their search for

4602-461: Is often referred to as limits to arbitrage . Generally, it is impossible to close two or three transactions at the same instant; therefore, there is the possibility that when one part of the deal is closed, a quick shift in prices makes it impossible to close the other at a profitable price. However, this is not necessarily the case. Many exchanges and inter-dealer brokers allow multi legged trades (e.g. basis block trades on LIFFE). Competition in

4720-465: Is that such a spread will eventually be zero, if and when the takeover is completed. The risk is that the deal "breaks" and the spread massively widens. Also called municipal bond relative value arbitrage , municipal arbitrage , or just muni arb , this hedge fund strategy involves one of two approaches. The term "arbitrage" is also used in the context of the Income Tax Regulations governing

4838-403: Is the practice of taking advantage of a difference in prices in two or more markets  – striking a combination of matching deals to capitalize on the difference, the profit being the difference between the market prices at which the unit is traded . When used by academics, an arbitrage is a transaction that involves no negative cash flow at any probabilistic or temporal state and

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4956-532: Is the simplest form of arbitrage. In spatial arbitrage, an arbitrageur looks for price differences between geographically separate markets. For example, there may be a bond dealer in Virginia offering a bond at 100-12/23 and a dealer in Washington bidding 100-15/23 for the same bond. For whatever reason, the two dealers have not spotted the difference in the prices, but the arbitrageur does. The arbitrageur immediately buys

5074-415: Is used to magnify the reward through leverage. One way of reducing this risk is through the illegal use of inside information , and risk arbitrage in leveraged buyouts was associated with some of the famous financial scandals of the 1980s, such as those involving Michael Milken and Ivan Boesky . Another risk occurs if the items being bought and sold are not identical and the arbitrage is conducted under

5192-407: Is very simple: at each exchange of a currency into another a small tax would be levied - let's say, 0.5% of the volume of the transaction. This dissuades speculators as many investors invest their money in foreign exchange on a very short-term basis. If this money is suddenly withdrawn, countries have to drastically increase interest rates for their currency to still be attractive. But high interest

5310-731: The Council of the European Union in January 2013. The formal agreement on the details of the EU FTT still need to be decided upon and approved by the European Parliament. Wrobel's paper highlighted the Swedish experience with financial transaction taxes. In January 1984, Sweden introduced a 0.5% tax on the purchase or sale of an equity security. Thus a round trip (purchase and sale) transaction resulted in

5428-473: The Tobin tax idea. He stated, "I think there is a case for a Tobin tax... (but) it is not at all clear to me that a Tobin tax would reduce volatility in the currency markets. It is true that it may discourage currency speculation but it would also reduce the liquidity of the marketplace." In 1994, Canadian economist Rodney Schmidt noted that "in two-thirds of all the outright forward and currency swap transactions ,

5546-598: The United Nations manage a Tobin tax would solve this problem and would give the UN a large source of funding independent from donations by participating states. However, there have also been initiatives of national dimension about the tax. (This is in addition to the many countries that have foreign exchange controls .) Whilst finding some support in countries with strong left-wing political movements such as France and Latin America ,

5664-526: The United States dollar would no longer be convertible to gold , effectively ending the system. This action created the situation whereby the U.S. dollar became the sole backing of currencies and a reserve currency for the member states of the Bretton Woods system, leading the system to collapse in the face of increasing financial strain in that same year. In that context, Tobin suggested a new system for international currency stability, and proposed that such

5782-642: The automated payment transaction (APT) tax and on international currency transactions, the Tobin tax and the Spahn tax . The automated payment transaction (APT) tax was first proposed in Buenos Aires at the International Institute of Public Finance Conference by Edgar L. Feige in 1989 and an extended version of the proposal appeared in Economic Policy in 2000. The APT tax proposal is a generalization of

5900-402: The y -axis. Since the yield curve displays market expectations on how yields and interest rates may move, the arbitrage-free pricing approach is more realistic than using only one discount rate. Investors can use this approach to value bonds and find price mismatches, resulting in an arbitrage opportunity. If a bond valued with the arbitrage-free pricing approach turns out to be priced higher in

6018-463: The 2010s the Basel II and Basel III frameworks required reporting that would help to differentiate them and economic thought was tending to reject the belief that they could not be differentiated, or (as the "Chicago School" had held) should not be. In March 2016 China drafted rules to impose a genuine currency transaction tax and this was referred to in financial press as a Tobin tax [1] . This

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6136-420: The 30 days prior to the announcement. When the tax was doubled, prices again fell by another 1%. These declines were in line with the capitalized value of future tax payments resulting from expected trades. It was further felt that the taxes on fixed-income securities only served to increase the cost of government borrowing, providing another argument against the tax. Even though the tax on fixed-income securities

6254-512: The APT tax imposes a tax rate on currency higher than the rate automatically charged on cheque transactions. Since cash can be used multiple times between the time it enters into circulation and the time it is returned to the banking system, the APT currency transaction tax is set at a multiple of the rate charged for all other transactions using non cash payment methods. A Tobin tax is a tax on all spot conversions of one currency into another. Named after

6372-539: The Keynes tax and the Tobin tax. The APT tax consists of a small flat tax levied on all transactions. The tax is automatically assessed and collected when transactions are settled through the electronic technology of the banking or payments system. In order to assure that all cash transactions are also taxed, the APT system proposes to exact a tax on currency as it enters and leaves the banking system. In order to be an effective means of discouraging currency usage for tax evasion,

6490-520: The LSE, and due to the strong growth of the contract for difference (CFD) industry, which provides UK investors with untaxed substitutes for LSE stocks, according to the Oxera (2007) report, more than 70% percent of the total UK stock market volume, including the entire institutional volume remained (in 2005) exempt from the Stamp Duty, in contrast to the common perception of this tax as a "tax on bank transactions" or

6608-401: The Tobin tax could be devoted to the world's fight against climate change, especially in developing countries. They suggested that funding could come from "a global financial transactions tax." However British officials later argued the main point of a financial transactions tax would be provide insurance for the global taxpayer against a future banking crisis." This scenario is possible, given

6726-475: The Tobin tax idea. He stated, "I think there is a case for a Tobin tax ... (but) it is not at all clear to me that a Tobin tax would reduce volatility in the currency markets. It is true that it may discourage currency speculation but it would also reduce the liquidity of the marketplace." In this Soros appeared to agree with the Chicago School. The term "Tobin tax" has sometimes been used interchangeably with

6844-431: The Tobin tax proposal came under much criticism from economists and governments, especially those with liberal markets and a large international banking sector, who said it would be impossible to implement and would destabilise foreign exchange markets. Most of the actual implementation of Tobin taxes, whether in the form of a specific currency transaction tax , or a more general financial transaction tax , has occurred at

6962-419: The UK government. The Sterling Stamp Duty, as it became known, was to be set at a rate 200 times lower than Tobin had envisaged in 2001, which "pro Tobin tax" supporters claim wouldn't have affected currency markets and could still raise large sums of money. The global currency market grew to $ 3,200 billion a day in 2007, or £400,000 billion per annum with the trade in sterling, the fourth most traded currency in

7080-682: The US and doubts at the IMF itself. In a communiqué issued after a two-day summit, the EU's 27 national leaders stopped short of making a formal appeal for the introduction of a so-called "Tobin tax" but made clear they regarded it as a potentially useful revenue-raising instrument. It was originally assumed that the Tobin tax would require multilateral implementation, since one country acting alone would find it very difficult to implement this tax. Many people have therefore argued that it would be best implemented by an international institution. It has been proposed that having

7198-409: The assumption that the prices of the items are correlated or predictable; this is more narrowly referred to as a convergence trade . In the extreme case this is merger arbitrage, described below. In comparison to the classical quick arbitrage transaction, such an operation can produce disastrous losses. As arbitrages generally involve future movements of cash, they are subject to counterparty risk :

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7316-422: The average was closer to 50 million. In addition, as taxable trading volumes fell, so did revenues from capital gains taxes, entirely offsetting revenues from the equity transactions tax that had grown to 4,000 million Swedish kronor by 1988. On the day that the tax was announced, share prices fell by 2.2%. But there was leakage of information prior to the announcement, which might explain the 5.35% price decline in

7434-522: The bond from the Virginia dealer and sells it to the Washington dealer. Also known as interexchange arbitrage, this is the form of arbitrage that takes advantage of the difference between two or more crypto exchanges. For example, on HTX token like LSK could be priced at $ 1.39 while on Gate it could be sold for $ 1.5. Although there are some risks involved in that type of arbitrage, such as network and exchange fees, blockchain overload, and inability to deposit or withdraw funds, this activity remains one of

7552-436: The bonds in t 1 move closer together to finally become the same at t T . Arbitrage may take place when: Arbitrage is not simply the act of buying a product in one market and selling it in another for a higher price at some later time. The transactions must occur simultaneously to avoid exposure to market risk, or the risk that prices may change in one market before both transactions are complete. In practical terms, this

7670-540: The current level of 0.5%. The changes in Stamp Duty rates in 1974, 1984, and 1986 provided researchers with "natural experiments", allowing them to measure the impact of transaction taxes on market volume, volatility, returns, and valuations of UK companies listed on the London Stock Exchange . Jackson and O'Donnel (1985), using UK quarterly data, found that the 1% cut in the Stamp Duty in April 1984 from 2% to 1% lead to

7788-472: The current price, if the merger goes through as predicted. Traditionally, arbitrage transactions in the securities markets involve high speed, high volume, and low risk. At some moment a price difference exists, and the problem is to execute two or three balancing transactions while the difference persists (that is, before the other arbitrageurs act). When the transaction involves a delay of weeks or months, as above, it may entail considerable risk if borrowed money

7906-471: The difference between the bond spread and the CDS premium, in a financial crisis, the bonds may default and the CDS writer/seller may fail, due to the stress of the crisis, causing the arbitrageur to face steep losses. Arbitrage trades are necessarily synthetic, leveraged trades, as they involve a short position. If the assets used are not identical (so a price divergence makes the trade temporarily lose money), or

8024-472: The difference in interest rates paid on government bonds issued by the various countries, given the expected depreciation in the currencies relative to each other (see interest rate parity ). Arbitrage transactions in modern securities markets involve fairly low day-to-day risks, but can face extremely high risk in rare situations, particularly financial crises , and can lead to bankruptcy . Formally, arbitrage transactions have negative skew – prices can get

8142-446: The discount rate may differ for each cash flow. Each cash flow can be considered a zero-coupon instrument that pays one payment upon maturity. The discount rates used should be the rates of multiple zero-coupon bonds with maturity dates the same as each cash flow and similar risk as the instrument being valued. By using multiple discount rates, the arbitrage-free price is the sum of the discounted cash flows . Arbitrage-free price refers to

8260-413: The duration risk hedged by shorting the appropriate ratio of taxable corporate bonds. These corporate equivalents are typically interest rate swaps referencing Libor or SIFMA . The arbitrage manifests itself in the form of a relatively cheap longer maturity municipal bond, which is a municipal bond that yields significantly more than 65% of a corresponding taxable corporate bond. The steeper slope of

8378-550: The earlier work of John Maynard Keynes on general financial transaction taxes. Keynes' concept stems from 1936 when he proposed that a transaction tax should be levied on dealings on Wall Street , where he argued that excessive speculation by uninformed financial traders increased volatility. For Keynes (who was himself a speculator ) the key issue was the proportion of 'speculators' in the market, and his concern that, if left unchecked, these types of players would become too dominant. The most common variations on Tobin's idea are

8496-482: The economist James Tobin , the tax is intended to put a penalty on short-term financial round-trip excursions into another currency. Tobin suggested his currency transaction tax in 1972 in his Janeway Lectures at Princeton, shortly after the Bretton Woods system effectively ended. In 1995, Paul Bernd Spahn suggested an alternative involving "a two-tier rate structure consisting of a low-rate financial transactions tax, plus an exchange surcharge at prohibitive rates as

8614-415: The effect of causing prices of the same or very similar assets in different markets to converge. "Arbitrage" is a French word and denotes a decision by an arbitrator or arbitration tribunal (in modern French, " arbitre " usually means referee or umpire ). In the sense used here, it was first defined in 1704 by Mathieu de la Porte in his treatise " La science des négociants et teneurs de livres " as

8732-543: The events in May and June, 2010: Currency transaction tax A currency transaction tax is a tax placed on the use of currency for various types of transactions. The tax is associated with the financial sector and is a type of financial transaction tax , as opposed to a consumption tax paid by consumers, though the tax may be passed on by the financial institution to the customer. Currency transaction taxes have been proposed as taxes on domestic currency usage as part of

8850-460: The exchange of shares and bonds and 0.01% across derivative contracts . According to the European Commission it could raise €57 billion every year, of which around €10bn (£8.4bn) would go to Great Britain, which hosts Europe's biggest financial center. It is unclear whether a financial transaction tax is compatible with European law. If implemented the tax must be paid in the European country where

8968-474: The failure of the other participant in a substantial transaction, or a series of transactions, to fulfill their financial obligations. Liquidity risk, conversely, emerges when an entity is necessitated to allocate additional monetary resources as margin, but encounters a deficit in the required capital. In the academic literature, the idea that seemingly very low-risk arbitrage trades might not be fully exploited because of these risk factors and other considerations

9086-587: The financial operator is established. This "R plus I" (residence plus issuance) solution means the EU-FTT would cover all transactions that involve a single European firm, no matter if these transactions are carried out in the EU or elsewhere in the world. The scheme makes it impossible for say French or German banks to avoid the tax by moving their transactions offshore, unless they give up all their European customers. Being faced with stiff resistance from some non-eurozone EU countries, particularly United Kingdom and Sweden,

9204-568: The findings of previous studies, noting also that the impact of the announced tax rate cuts was more beneficial (increasing market value more significantly) in case of larger firms, which had higher turnover, and were therefore more affected by the transaction tax than stocks of smaller companies, less frequently traded. Because the UK tax code provides exemptions from the Stamp Duty Reserve Tax for all financial intermediaries, including market makers , investment banks and other members of

9322-686: The freedom to act in the best interests of their own economic development, rather than being forced to shape fiscal and monetary policies according to demands of fickle financial markets." In early November 2007, a regional Tobin tax was adopted by the Bank of the South in Latin America , after an initiative of Presidents Hugo Chavez from Venezuela and Néstor Kirchner from Argentina . Arbitrage In economics and finance , arbitrage ( / ˈ ɑːr b ɪ t r ɑː ʒ / , UK also /- t r ɪ dʒ / )

9440-613: The funding gap required to pay for the Millennium Development Goals . In 1996, the United Nations Development Programme sponsored a comprehensive feasibility and cost-benefit study of the Tobin tax: Haq, Mahbub ul; Kaul, Inge; Grunberg, Isabelle (August 1996). The Tobin Tax: Coping with Financial Volatility. Oxford University Press. ISBN   978-0-19-511180-4 . In late 2001, a Tobin tax amendment

9558-409: The inefficiency is related to government tax policy, and hence is structural in nature, it has not been arbitraged away. However, many municipal bonds are callable, and this adds substantial risks to the strategy. A convertible bond is a bond that an investor can return to the issuing company in exchange for a predetermined number of shares in the company. A convertible bond can be thought of as

9676-474: The interests of currency traders and the interests of ordinary citizens were operating at cross-purposes." "Schmidt also noted another interesting aspect of the foreign- exchange market: The dominant players were the private banks , which had huge pools of capital and access to information about currency values. Since much of the market involved moving large sums of money (typically in the tens of millions of dollars) for very short periods of time (often less than

9794-494: The investment of proceeds of municipal bonds; these regulations, aimed at the issuers or beneficiaries of tax-exempt municipal bonds, are different and, instead, attempt to remove the issuer's ability to arbitrage between the low tax-exempt rate and a taxable investment rate. Generally, managers seek relative value opportunities by being both long and short municipal bonds with a duration-neutral book. The relative value trades may be between different issuers, different bonds issued by

9912-403: The issue of a Tobin tax once again, suggesting it be adopted by the G20. On November 7, 2009, prime minister Gordon Brown said that G-20 should consider a tax on speculation, although did not specify that it should be on currency trading alone. The BBC reported that there was a negative response to the plan among the G20. By December 11, 2009, European Union leaders expressed broad support for

10030-404: The latter approach: "I therefore regretfully recommend the second, and my proposal is to throw some sand in the wheels of our excessively efficient international money markets." Tobin's method of "throwing sand in the wheels" was to suggest a tax on all spot conversions of one currency into another, proportional to the size of the transaction. In the development of his idea, Tobin was influenced by

10148-436: The margin treatment is not identical, and the trader is accordingly required to post margin (faces a margin call ), the trader may run out of capital (if they run out of cash and cannot borrow more) and be forced to sell these assets at a loss even though the trades may be expected to ultimately make money. In effect, arbitrage traders synthesise a put option on their ability to finance themselves. Prices may diverge during

10266-448: The market, an investor could have such an opportunity: If the outcome from the valuation were the reverse case, the opposite positions would be taken in the bonds. This arbitrage opportunity comes from the assumption that the prices of bonds with the same properties will converge upon maturity. This can be explained through market efficiency, which states that arbitrage opportunities will eventually be discovered and corrected. The prices of

10384-513: The marketplace can also create risks during arbitrage transactions. As an example, if one was trying to profit from a price discrepancy between IBM on the NYSE and IBM on the London Stock Exchange, they may purchase a large number of shares on the NYSE and find that they cannot simultaneously sell on the LSE. This leaves the arbitrageur in an unhedged risk position. In the 1980s, risk arbitrage

10502-452: The money moved into another currency for fewer than seven days. In only 1 per cent did the money stay for as long as one year. While the volatile exchange rates caused by all this rapid movement posed problems for national economies, it was the bread and butter of those playing the currency markets . Without constant fluctuations in the currency markets, Schmidt noted, there was little opportunity for profit." "This certainly seemed to suggest

10620-519: The most profitable ventures in crypto . For very short amounts of time, the prices of two assets that are either fungible or related by a strict pricing relationship may temporarily go out of sync as the market makers are slow to update the prices. This momentary mispricing creates the opportunity for an arbitrageur to capture the difference between the two prices. For example, the price of calls and puts on an underlying should be related by put-call parity . If these prices are misquoted relative to

10738-495: The municipal yield curve allows participants to collect more after-tax income from the municipal bond portfolio than is spent on the interest rate swap; the carry is greater than the hedge expense. Positive, tax-free carry from muni arb can reach into the double digits. The bet in this municipal bond arbitrage is that, over a longer period of time, two similar instruments—municipal bonds and interest rate swaps—will correlate with each other; they are both very high quality credits, have

10856-479: The optimum rate. Economic literature of the period 1990s-2000s emphasized that variations in the terms of payment in trade-related transactions (so-called "swaps" for instance) provided a ready means of evading a tax levied on currency only. Accordingly, most debate on the issue has shifted towards a general financial transaction tax which would capture such proxies. Other measures to avoid punishing hedging (a form of insurance for cashflows) were also proposed. By

10974-421: The other. See rational pricing , particularly § arbitrage mechanics , for further discussion. Mathematically it is defined as follows: where V 0 = 0 {\displaystyle V_{0}=0} , V t {\displaystyle V_{t}} denotes the portfolio value at time  t and T is the time the portfolio ceases to be available on the market. This means that

11092-645: The permissible range would become subject to tax. This would automatically induce stabilizing behavior on the part of market participants." On June 15, 2004, the Commission of Finance and Budget in the Belgian Federal Parliament approved a bill implementing a Spahn tax. According to the legislation, Belgium will introduce the Spahn tax once all countries of the eurozone introduce a similar law. In July 2005 former Austrian chancellor Wolfgang Schüssel called for

11210-421: The present. In the present-value approach, the cash flows are discounted with one discount rate to find the price of the bond. In arbitrage-free pricing, multiple discount rates are used. The present-value approach assumes that the bond yield will stay the same until maturity. This is a simplified model because interest rates may fluctuate in the future, which in turn affects the yield on the bond. For this reason,

11328-432: The price at which no price arbitrage is possible. The idea of using multiple discount rates obtained from zero-coupon bonds and discounting a similar bond's cash flow to find its price is derived from the yield curve, which is a curve of the yields of the same bond with different maturities. This curve can be used to view trends in market expectations of how interest rates will move in the future. In arbitrage-free pricing of

11446-440: The price is calculated with a present-value pricing approach. Arbitrage-free pricing is used for bond valuation and to detect arbitrage opportunities for investors. For the purpose of valuing the price of a bond, its cash flows can each be thought of as packets of incremental cash flows with a large packet upon maturity, being the principal. Since the cash flows are dispersed throughout future periods, they must be discounted back to

11564-693: The put-call parity relationship, it provides an arbitrageur the opportunity to profit from the mispricing. Latency arbitrage is often mentioned especially in electronic processing in the financial field, where the use of fast server hardware allows an arbitrageur to realize opportunities that may exist for as little as nanoseconds. A study by the Financial Conduct Authority of the United Kingdom found that this practice generates as much as $ 5 billion per year in profit. Also called risk arbitrage , merger arbitrage generally consists of buying/holding

11682-399: The rare event of a large price move, this may yield a large loss. The principal risk, which is typically encountered on a routine basis, is classified as execution risk. This transpires when an aspect of the financial transaction does not materialize as anticipated. Infrequent, albeit critical, risks encompass counterparty and liquidity risks. The former, counterparty risk, is characterized by

11800-399: The rates on the remaining taxes were cut in half and by the end of the year they were abolished completely. Once the taxes were eliminated, trading volumes returned and grew substantially in the 1990s and 2000s. The Swedish experience of a transaction tax was with purchase or sale of equity securities, fixed income securities and derivatives. In global international currency trading, however,

11918-508: The risk that a counterparty fails to fulfill their side of a transaction. This is a serious problem if one has either a single trade or many related trades with a single counterparty, whose failure thus poses a threat, or in the event of a financial crisis when many counterparties fail. This hazard is serious because of the large quantities one must trade in order to make a profit on small price differences. For example, if one purchases many risky bonds, then hedges them with CDSes , profiting from

12036-449: The same entity, or capital structure trades referencing the same asset (in the case of revenue bonds). Managers aim to capture the inefficiencies arising from the heavy participation of non-economic investors (i.e., high income " buy and hold " investors seeking tax-exempt income) as well as the "crossover buying" arising from corporations' or individuals' changing income tax situations (i.e., insurers switching their munis for corporates after

12154-408: The same maturity and are denominated in the same currency. Credit risk and duration risk are largely eliminated in this strategy. However, basis risk arises from use of an imperfect hedge, which results in significant, but range-bound principal volatility. The end goal is to limit this principal volatility, eliminating its relevance over time as the high, consistent, tax-free cash flow accumulates. Since

12272-535: The same price in another. Traders may, for example, find that the price of wheat is lower in agricultural regions than in cities, purchase the good, and transport it to another region to sell at a higher price. This type of price arbitrage is the most common, but this simple example ignores the cost of transport, storage, risk, and other factors. "True" arbitrage requires that there is no market risk involved. Where securities are traded on more than one exchange, arbitrage occurs by simultaneously buying in one and selling on

12390-429: The same services [thus] just as the market provides an incentive to avoid a Tobin tax, so too it automatically sets in motion forces that deter excessive avoidance." - Palley, 2000 Pollin, Palley and Baker (2000) emphasize that transaction taxes "have clearly not prevented the efficient functioning of these markets. " According to Paul Bernd Spahn in 1995, "Analysis has shown that the Tobin tax as originally proposed

12508-409: The situation could, some argue, look quite different. Wrobel's studies do not address the global economy as a whole, as James Tobin did when he spoke of "the nineties' crises in Mexico, South East Asia and Russia," which included the 1994 economic crisis in Mexico , the 1997 Asian Financial Crisis , and the 1998 Russian financial crisis . An existing example of a Financial Transaction Tax (FTT)

12626-417: The stock of a company that is the target of a takeover while shorting the stock of the acquiring company. Usually, the market price of the target company is less than the price offered by the acquiring company. The spread between these two prices depends mainly on the probability and the timing of the takeover being completed as well as the prevailing level of interest rates. The bet in a merger arbitrage

12744-399: The tax... [so] focusing on just spot currency markets would clearly induce a huge shifting of transactions into futures and derivatives markets. Thus, the real issue is how to design a tax that takes account of all the methods and margins of substitution that investors have for changing their patterns of activity to avoid the tax. Taking account of these considerations implies a Tobin tax that

12862-520: The value of the portfolio is never negative, and guaranteed to be positive at least once over its lifetime. Negative, or anti-, arbitrage is similarly defined as and occurs naturally in arbitrage relations as the seller view as opposed to the buyer view. Arbitrage has the effect of causing prices in different markets to converge. As a result of arbitrage, the currency exchange rates and the prices of securities and other financial assets in different markets tend to converge. The speed at which they do so

12980-489: The world's central banks put together. Official global reserves are less than half the value of one day of global foreign-exchange turnover. Many countries are simply unable to protect their currencies from speculative attack." "By cutting down on the overall volume of foreign-exchange transactions, a Tobin Tax would mean that central banks would not need as much reserve money to defend their currency. The tax would allow governments

13098-542: The world, worth £34,000 billion a year. A sterling stamp duty set at 0.005% as some claim would have raised in the region of £2 billion a year in 2007. The All Party Parliamentary Group for Debt, Aid and Trade published a report in November 2007 into financing for development in which it recommended that the UK government undertake rigorous research into the implementation of a 0.005% stamp duty on all sterling foreign exchange transactions, to provide additional revenue to help bridge

13216-560: Was Canada. On March 23, 1999, the House of Commons of Canada passed a resolution directing the government to "enact a tax on financial transactions in concert with the international community." However, ten years later, in November 2009, at the G20 finance ministers summit in Scotland, the representatives of the minority government of Canada spoke publicly on the world stage in opposition to that House of Commons of Canada resolution. In September 2009, French president Nicolas Sarkozy brought up

13334-567: Was adopted by the French National Assembly . However, it was overturned by March 2002 by the French Senate . On June 15, 2004, the Commission of Finance and Budget in the Belgian Federal Parliament approved a bill implementing a Spahn tax . According to the legislation, Belgium will introduce the Tobin tax once all countries of the eurozone introduce a similar law. In July 2005 former Austrian chancellor Wolfgang Schüssel called for

13452-427: Was common. In this form of speculation , one trades a security that is clearly undervalued or overvalued, when it is seen that the wrong valuation is about to be corrected. The standard example is the stock of a company, undervalued in the stock market, which is about to be the object of a takeover bid; the price of the takeover will more truly reflect the value of the company, giving a large profit to those who bought at

13570-451: Was his sister, Christine Van Rompuy, who said, "any new taxes would directly affect the poor". On June 29, 2011, the European Commission called for Tobin-style taxes on the EU's financial sector to generate direct revenue starting from 2014. At the same time it suggested to reduce existing levies coming from the 27 member states. The first nation in the G20 group to formally accept the Tobin tax

13688-399: Was much lower than that on equities, the impact on market trading was much more dramatic. During the first week of the tax, the volume of bond trading fell by 85%, even though the tax rate on five-year bonds was only 0.003%. The volume of futures trading fell by 98% and the options trading market disappeared. On 15 April 1990, the tax on fixed-income securities was abolished. In January 1991

13806-451: Was to move "toward a common currency, common monetary and fiscal policy, and economic integration." The second was to move "toward greater financial segmentation between nations or currency areas, permitting their central banks and governments greater autonomy in policies tailored to their specific economic institutions and objectives." Tobin's preferred solution was the former one but he did not see this as politically viable so he advocated for

13924-595: Was widely viewed as a warning to curb shorting of its currency the yuan . It was however expected to keep this tax at 0% initially, calculating potential revenue from different rate schemes and exemptions, and not to impose the actual tax unless speculation increased. Also in 2016 US Democratic Party POTUS nominee Hillary Clinton included in her platform a vow to "Impose a tax on high-frequency trading. The growth of high-frequency trading has unnecessarily placed stress on our markets, created instability, and enabled unfair and abusive trading strategies. Hillary would impose

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