Noise Trader and the Limits to Arbitrage: Evidence from Taiwan Financial Transaction Tax Reform

Ching-Tse Chen, Finance PhD student

The study aims to examine the effect of noise trading on financial market and the validity of noise trader risk as a source of limits to arbitrages. In particular, I would like to test whether an increase in noise trader affect market volatility and firms’ dividend policy using a quasi-experiment from Taiwan. This reform exogenously lower the day trader transaction tax imposed by Taiwanese government by half, from 30 bps to 15 bps and, thus, the volume of day trading almost double on the day when this policy takes effect. In this study, I will present evidence and argue that day traders as a group can be think of as noise traders. Hence, the quasi-experiment in Taiwan allows us to study how an exogenous increase in noise traders affects the market and to verify noise trader risk as a source of limits to arbitrage.