Tobin or not Tobin?

By Emanuel Derman
August 18, 2011

If there’s one larger lesson one learns from options theory that transcends its technical details, it’s that there aren’t unmitigated goods. Every benefit thing has its price. Convexity/optionality is valuable, but its downside is rapid time decay.You can’t have your cake and eat it (unless you notice a kind of convexity that no one else has yet recognized).

Liquidity too is not an unmitigated good, and the world recognizes this in many important issues by creating friction and viscosity to slow things down. Without friction some things would never happen and life couldn’t go on.

You can have friction in the time dimension. People used to get engaged before they got married, then wait again for a marriage license, pass blood tests, etc. Divorce takes time, too. If you only join a gym, you have a few days to change your mind. Illiquidity makes people pause and think about the long run. Wall Street partnerships and the illiquidity of partners’ assets made firms think long term.

You can have friction in space. Co-op buildings outlaw or tax the flipping of apartments, for the benefit of the long-term residents. Some stock markets have circuit breakers to slow things down. Some countries impose a stamp tax on stock buying and selling. Glass-Steagall imposed barriers on mixing lending with trading.

Statistical arbitrage firms claim to be a liquidity providers and therefore good for you. It’s not self-evident at all. And if it does provide liquidity, it is the kind of liquidity you can do without if you’re a long-term resident of the market. If a little liquidity is good is more better? Not so obvious.

Too much friction may be bad, but a little friction is often a good thing.

A Merkel-Sarkozy Tobin-style transactions tax on trading is worth trying, but not because it raises money for the government. It’s good because it puts a small amount of sand in the gears of frivolity whose demand for increased lubrication only seems to be useful, and therefore makes people wait a bit before they act. If the same pause could be achieved without taxation — for example by putting a random delay in the transmission and withdrawal of electronic orders — maybe that might be OK too.


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please deatil the impact of the Tobin tax on Sweden just so we can have a balanced article – they abaandoned it as it raised only 1/30 of intended receipts and all banks moved their offices abroad. So I guess history shows it as a disaster. Worth a try – it seems the media is as useless as the politicians.

Posted by charlieboy | Report as abusive

Too much friction may be bad, but a little friction is often a good thing. It’s true!!

Posted by nightdynast | Report as abusive

Derman on Friction is reminiscent of Black on Noise.

What are our prospects for finding a jurisdiction capable of giving law to our Masters of the Universe?

Posted by SethTS | Report as abusive

To nightdynast: Yes, no life without friction. In my book, to carry this theme farther, I have a section on the history of electromagnetism, to show how new theories are discovered. People used to generate electricity via friction (Leyden jars). Then Volta invented the voltaic pile (battery). It took an Italian to discover that chemistry is better than friction.