Costs and benefits of speculation

Abstract

We quantify the effects of financial regulation in an equilibrium model with delegated portfolio management. Fund managers trade stocks and bonds in an order-driven market, subject to transaction taxes and constraints on short-selling and leverage. Results are obtained on the equilibrium properties of portfolio choice, trading activity, market quality and price dynamics under the different regulations. We find that short- sale restrictions reduce short-term volatility and long swings in asset prices, while transaction taxes do more harm than good.