Cleaning the gears: Counter-cyclical asset trading with financial transactions taxes

• I model labor risk and aggregate risk in a DSGE framework with incomplete markets.
• Imposition of frictions in financial markets lead to higher coefficient of variation of consumption.
• Frictions lead to higher incidence of constrained credit on agent's behalf.
• Households switch trading to unemcumbered markets to reduce costs.

This paper analyzes the effect of financial transactions taxes (FTT) and idiosyncratic income risk on counter-cyclical asset trading. The model is in the class of DSGE models with incomplete markets. The paper is able demonstrate the potential welfare loss from the imposition of FTT on agents through two factors: higher coefficient of variation of consumption and higher incidence of constrained credit. The paper is also able to demonstrate the effect of FTTs on the market through three factors: significantly lower trading volume, higher variance in unencumbered markets, higher volume in unencumbered markets.