Taxation in an Asset Pricing Model with Dispersed Information

We look at a model of asset pricing and analyze how taxes can be used toreduce both economic and informational inefficiencies. The framework we consideris one in which there is a continuum of risk averse agents choosing their... [ view full abstract ]

We look at a model of asset pricing and analyze how taxes can be used toreduce both economic and informational inefficiencies. The framework we consideris one in which there is a continuum of risk averse agents choosing their demandsfor a single risky asset. Traders face uncertainty and maximize conditioning onthe observed price and private signal. The environment we consider is similar tothe ones in Hellwig (1980) and Diamond and Verrechia (1981). We find that thecompetitive noisy rational expectations equilibrium is not efficient in the sense thatit does not solve the team problem. We then look at taxation policies and showthat a tax on returns can be used to improve upon the market solutions and also toreduce price informational inefficiency. However, we show that in order to achievesemi-strong price informational efficiency the planner needs to use a transactiontax that depends both on the size and monetary value of the trade. Finally, weconclude that when the planner faces budgetary restrictions, there may exist atrade-off between price informational efficiency and team efficiency.