㼀㼔㼑㻌㻿㼛㼏㼕㼑㼠㼥㻌㼒㼛㼞㻌㻱㼏㼛㼚㼛㼙㼕㼏㻌㻿㼠㼡㼐㼕㼑㼟㻌㻌㻌㼀㼔㼑㻌㼁㼚㼕㼢㼑㼞㼟㼕㼠㼥㻌㼛㼒㻌㻷㼕㼠㼍㼗㼥㼡㼟㼔㼡㻌㻌㼃㼛㼞㼗㼕㼚㼓㻌㻼㼍㼜㼑㼞㻌㻿㼑㼞㼕㼑㼟㻌㻺㼛㻚㻞㻜㻝㻜㻙㻝㻌㻌㻌㻌㻌㻌㻔㼍㼏㼏㼑㼜㼠㼑㼐㻌㼕㼚㻌㻞㻌㻭㼡㼓㻚㻌㻞㻜㻝㻜㻕

Tax Reforms and Stock Return Volatility: The Case of Japan
Minoru Hayashida1 and Hiroyuki Ono2ͤ

Abstract
Japan abolished its stock transaction tax in 1999 and streamlined the capital gains tax in 2003, inorder to revitalize its ailing stock market and economy at large during the recession. These tax
reforms provide an excellent opportunity to revisit the important issue of stock market stability
and taxation in finance, taking advantage of recent advances in modeling stock return volatility.
Using a few GARCH-type models incorporating the so-called leverage effect, this paper
examines whether and how the tax reforms affected return volatility through a reduction intransaction cost. The estimation yields some evidence that the 1999 reform reduced volatility.
Such evidence for the 2003 reform is much stronger. These results are in line with earlier
findings based on the concept of historical volatility.

JEL codes: G150, G180, H240

Key Words: stock return volatility, taxation, Japan

1

Professor, Department of Economics and Business Administration, The University of Kitakyushu; 4-2-1
Kitagata, Kokura-minami-ku, Kitakyushu 802-8577, Japan; Phone +81-93-964-4089; Fax +81-93-964-4115;
Email: hayasida@kitakyu-u.ac.jp
2
Corresponding author; Professor, Faculty of Economics, Toyo University; 5-28-20, Hakusan, Bunkyo-ku,
Tokyo 112-8606, Japan; Phone +81-3-3945-7411; Fax +81-3-3945-7667; Email: hiroono@toyonet.toyo.ac.jp
ͤThe authors are grateful to the Zengin Foundation for Studies on Economics and Finance for granting financial
support essential to conduct this study.

1

1. Introduction
The effect of taxation on the stability of stock markets has been one of the most important
issues in both policy-making debates and academic discourse in finance. Just after the Black
Monday market plunge in 1987, for example, a debate occurred in the United States on whether
the country should re-introduce a stock transaction tax, which had been abolished many years
earlier. Those supporting the idea claimed that the tax would increase the cost of transaction,
keep out noise traders, and stabilize the market [Stiglitz:1989, Summers and Summers (1989)].
Those opposing the tax, on the other hand, argued that such a claim was not grounded in solid
empirical evidence and that a higher transaction cost would adversely affect rational tradersequally or even more than noise traders [Hakkio:1991]. They claimed, therefore, that the tax
would destabilize, rather than stabilize, the market. Similar debates occurred in other countires,such as France, Germany, and Sweden, but eventually faded out as many abolished theirtransaction taxes, hoping to keep an international competitive edge for their stock markets. Sometwenty years later, there seems to be a renewed interest in the issue in the aftermath of the recent
global financial crisis, as leaders in industrialized economies discuss the need for a new tax to
avoid the recurrence of similar turmoil in the future3.
It is only natural that these policy debates have initiated academic discourse and prompted
research. Focusing on stock return volatility, several studies have been conducted on the subject
to date. For example, Roll [1989] examined the issue with cross-country data from 23 countries
and found no significant effect. With data from Sweden, Umlauf [1993] concluded that the
introduction of a turnover tax in the country did not reduce volatility. Hu [1998] obtained similarfindings from tax reform episodes of four Asian countries. Lindgren [1994] used data from 14
countries for 11 years and concluded that a turnover tax of above 0.5% increases volatility, while
one with a lower rate has no effect. Noronha and Ferris [1992] took up a capital gains tax andfound evidence that an increase in the tax rate leads to an increase in volatility. Although existingstudies seem to support the hypothesis that tax cuts have no or possibly a negative effect, onvolatility, but not a positive one, they are all based on the concept of historical volatility.
Advances have since been made in modeling stock return volatility in finance, establishing ageneralized ARCH (GARCH) model and its variants as standard tools of analysis. However, theissue of taxation and return volatility remains largely unexplored in these frameworks4.
3

Leading politicians of European countries, such as Angela Merkel, Nicolas Sarközy and Gordon Brown, haverepeatedly mentioned the Tobin tax since the G20 financial summit in Pistuburg in September 2009. Pushed by
the agreement at the summit, IMF submitted to G20 a report «Global Financial Stability Report: Meeting New
Challenges to Stability and Building a Safer System», advising a financial activity tax for policy consideration in
the Toronto summit in June 2010.
4
The only exception known to the authors is Saporta and Kan [1997], who examined the UK stamp duty in astandard GARCH model and found no significant effect on volatility. The present study distinguishes itself from2

Recent tax reforms in Japan provide an excellent opportunity to explore this issue. As is wellknown, starting in 1990 the country experienced a severe, prolonged recession over a decade. As
the most important cause was generally considered to be an inefficient financial sector, thecountry has enacted a series of reforms in the past ten years or so, in quest of a more competitive
financial sector. Tax reform was a main pillar of the reform. In October 1999 the 40-year-old
stock transaction tax (hereafter STT) was abolished, in the hope that a reduction of transaction
costs would maintain the Tokyo market’s standing as a world financial center. Further, in April
2003, the country streamlined the complicated systems of its capital gains tax, which in a peculiar
manner had functioned as a de facto STT. These reforms are believed to have cut the cost oftransaction a great deal. Therefore, these reforms are of great relevance in the long debated,unresolved issue of the effect of taxation on stock market stability. A closer examination of themarket at the times of the reforms would shed new light on the issue.
The paper is organized as follows. The next section explains the institutional aspects of theJapanese tax reforms in some detail. The third section explains the methodology and data. The
fourth section reports the results. The final section concludes the paper with caveats and venues
for possible future extensions.

2. Japanese Tax Reforms
2.1. Background
The Japanese financial sector was one of the country’s most heavily regulated sectors before
the 1990s. The government was overly concerned with the stability of the financial system anddid not, basically, allow financial institutions to compete, lose, and go bankrupt. However, thecollapse of the bubble economy in 1990 revolutionized this «philosophy» of the government withrespect to administration of the sector. Over-protection over many years had fosteredirresponsible attitudes in the management of financial institutions, including a sense that they
could never go bankrupt because the government would bail them out in the end; this had led toexcessive lending during the bubble period. After rigorous policy debates, in 1996 thegovernment initiated large-scale deregulation, popularly known as the «Financial Big Bang», inorder to strengthen the financial sector through greater competition.
One of the main goals of this reform was to bring more individual investors into the market. It
had long been pointed out that Japanese households were disproportionately inclined towards
bank deposits. Bringing in more individual investors, thereby expanding the market, wastheirs by using an EGARCH model, which incorporates observed asymmetry in the behaviors of stock return
volatility.

3

considered necessary for the success of the reform. One of the factors impeding the participationof individuals was the tax system. Since 1951, the country had had a turnover tax on stock
trading (an STT), rasing the cost of trading. The capital gains tax, introduced in 1989, also hadvery complicated methods of calculating tax liability. These features of the financial taxes were
believed to drive individual investors away. Therefore, the government implemented a series oftax reforms. After two minor rate reductions, the government abolished the STT in April 1999. It
then streamlined the complicated system of the capital gains tax and greatly reduced the tax ratein April 2003. These reforms were the first serious reforms in financial taxes in many decades in
the history of the Japanese tax system. As can be seen in Graph 1, the Japanese stock market
made a turn-around just after the capital gains tax reform in April, 2003.

Graph 1: Stock market and tax reforms in Japan (1987-2006)yen㻠㻡㻘㻜㻜㻜
㻠㻜㻘㻜㻜㻜

㻼㼑㼍㼗㻌㼢㼍㼘㼡㼑㻌㼛㼒㻌㻟㻤㻘㻜㻜㻜㼥㼑㼚㻟㻡㻘㻜㻜㻜
㻟㻜㻘㻜㻜㻜

㻿㼀㼀㻌㼞㼑㼐㼡㼏㼠㼕㼛㼚㻌㻔㻥㻢㻚㻜㻠㻕ᵠᶓᶀᶀᶊᶃᴾ
ᶀᶓᶐᶑᶒ㻿㼀㼀㻌㼞㼑㼐㼡㼏㼠㼕㼛㼚㻌㻔㻥㻤㻚㻜㻠㻕㻞㻡㻘㻜㻜㻜

㻯㼍㼜㼕㼠㼍㼘 㼓㼍㼕㼚㼟㻌㼍㼚㼐㻌㼐㼕㼢㼕㼐㼑㼚㼐㻌㼠㼍㼤㻌㻌㼞㼑㼒㼛㼞㼙㼟㻌㻔㻜㻟㻚㻜㻠㻕㻞㻜㻘㻜㻜㻜
㻝㻡㻘㻜㻜㻜
㻝㻜㻘㻜㻜㻜

㻿㼀㼀㻌㼍㼎㼛㼘㼕㼠㼕㼛㼚㻌㻔㻥㻥㻚㻜㻠㻕

㻡㻘㻜㻜㻜
㻜

(Note) The vertical axis measures the Nikkei 225 average stock price.

2.2. Abolition of STT in 1999
Japan introduced a turnover tax in 1937, but abolished it in 1950 following a de facto order of

the allied occupation forces5. As early as 1953, however, it was reintroduced, when the newly
introduced capital gains tax under Dr. Shoup’s advice was abolished on the grounds that it would
have an adverse effect on capital accumulation, which was much needed for recovery after thewar. In the period following, the STT rate was increased four times: 1957, 1973, 1978, and 1981.

5

This is referred to as the Shoup Advisory Opinion, named after Dr. Carl Shoup of Columbia University, whoheaded the expert group to formulate the opinion. It covered a wide range of taxes and, when implemented,
overhauled the overall tax system. Although termed an advisory opinion, it was a de facto order from theoccupation forces command.

4

In the late 1980s, with the stock market booming and the proposed abolition of a tax-freetreatment on small-amount savings6, a strong voice arose claiming that mounting capital gains
from stock trading accruing only to a small number of investors should be taxed for the equity ofthe overall tax system. The securities industry was vehemently opposed, claiming that theaddition of this new tax would dampen the stock market7. It also argued that the plan would run
against the gradually prevailing notion that the high transaction costs of Japan’s financial markets
must be reduced if they were to become internationally competitive markets8 . As a politicalcompromise, the STT rate was reduced for the first time when the capital gains tax was
reintroduced in 1989 at the peak of the stock investment boom.
When the stock market fell into a great slump in the 1990s, further tax cuts were seriously
debated. The industry pushed for it, invoking the aforementioned notion, and politicians ingeneral were supportive; this was because the tax cuts were expected to reduce cost of transaction
and thus to boost stock market trading. The Finance Ministry, on the other hand, was against it,
arguing that it would aggravate the revenue shortage due to the downfall of the economy. The
Ministry also argued that commission fees must be liberalized first to reduce transaction cost. As
a result of this debate, which continued throughout the latter half of the 1990s, the STT was cut
twice, in 1996 and 1998, before being completely abolished in April 1999. In this reform, therates for brokerage firms’ trading and other trading, including individual trading, were reduced
0.006% and 0.01%, respectively, down to zero9.

2.3. Streamlining of the Capital Gains Tax in 2003
The capital gains tax in Japan was introduced in 1989, in order to cool the overly heated stock
market at that time and to bring more equity into the overall tax system by taxing more theemerging “nouveau riche” who were making great profits in stock investments. Since then, thetax has been levied separately from other categories of personal income, with a flat rate different
from that applied in the general income tax scheme. The rate was originally 26% (20% fornational tax and 6% for local tax). However, before the reform in 2003, unique payment options
existed, by which individual investors could choose either to pay the tax in the self-assessed
income tax filing at the end of the tax year, or to pay at source with tax withholding in each
6Known as “Maruyu,” this allowed households to hold such assets as bank and postal savings deposits and bondsof up to 3 million yen tax-free at the time of abolition. Households with heads disabled or older than 64 years
continued to be eligible even after the 1989 tax reform.
7
Nihon Keizai Shinbun, February 29, 1988, page 5.
8See, for example, Nihon Keizai Shinbun, December 24, 1986, page 13.
9
In the following analysis, we take up only the reform in 1999, not the previous two cases, because they wererelatively minor and fee liberalization occurred concurrently, so that the pure effect of the tax reform cannot be
extracted.

5

transaction. However, if an investor chose the second option, the “pseudo capital gains rule”
applied, where 5.25 % of the sales value was automatically considered to be the taxable capitalgains, regardless of the price at which the stock was originally purchased. In this case, the local
tax was waived. Therefore, 1.05 % of the sales value was automatically withheld as a tax liability.
This unusual payment option was introduced because of the strong concern for a payment costhike voiced among securities dealers and individual investors alike. It is well known within the
securities trading community that most individual investors chose this tax withholding option.
Note that, in this special scheme, the capital gains tax functioned as a de facto STT, even after the
STT was abolished in April, 1999.
The 2003 tax reform streamlined this complex institution. It abolished the tax withholding
option in principle and unified the payment methods under the self-assessed tax filing 10 .
Considering concern that the abolition would lead to an overall tax increase and weaken theabout-to-recover stock market, the tax rate was also reduced from 26 % to 10 % until December
2006. Table 1 reports the estimated average tax rate from 1998 to 2004. The rate clearly dropped
in 2003.

Year

1998
1999
2000
2001
2002
2003
2004

Table 1: Estimated average rates of the capital gains tax
(A)
(B)
(C)
(D)
Tax
Estimated tax revenues
Capital gains Capital gains
revenues inin the self-assessed tax
income inincome inthe(A)×26% prior to Dec
the selfthe
assessed tax
withholding
withholding
2002and (A)×10%
tax
tax
afterwards
307,510506,302101,260
79,953
509,596
2,082,670
416,534
132,495
544,080
1,927,301
385,460
141,461448,347
904,052
180,810
116,570
326,767
984,155
195,831
84,959880,907766,814
76,68188,091
1,356,958
1,422,373
142,237
135,696(E)
Average tax
rate{(C)+(D)}/{(A)+(B)}
22.12621.17921.32121.98621.49610.00010.000(Note) Figures in columns (A), (B), and (C) are published in the National Tax Agency Statistical Annuals, except
for those in column (C) for 2003 and 2004. They are calculated by multiplying the corresponding values incolumn (B) by the tax rate of 10%, as the figures covering the national and local taxes were no longer publishedin and after 2003. Figures in (B) are pseudo capital gains, which is 5.25% of the sales values. Figures for 2003
and 2004 are those for the special purpose accounts.

3. Methodology and Data
3.1. Methodology

10

The reform also admitted, for the first time, carryover of losses for up to three years. However, it did not admit
gains/losses totaling with other income categories. Furthermore, given deep-rooted concern for the high payment
cost, the reform introduced a loophole measure to maintain the tax withholding payment. Investors can open a“special purpose account” and can pay tax at source from it, just as before 2003.

6

In empirical investigations of stock return volatility, it is now a standard practice to use a
GARCH-type model. Within this class, a number of variants have been proposed to incorporate
the generally observed asymmetry of the return volatility, known as the leverage effect, where
bad news, which brings down the price, has a greater impact on volatility than good news.
Among such models, we employ the following three models to check the robustness of theresults: the exponential GARCH (EGARCH) model first proposed by Nelson [1991], thethreshold ARCH (TARCH) model by Zakonian [1994], and the power ARCH (PARCH) modelby Ding et al. [1991].
The EGARCH (p, q) model consists of two equations. The mean equation is the same as astandard GARCH model:

¦ bR

Rt

a

Ht

V t ztm
i 1 i

i m  H t

,

(1)

where

Vt ! 0z t ~ i.i.d .(0,1)

For simplicity, we set m=1 in the present analysis. Engle et al. [1987] suggested that variance belinearly added to the right hand side of Equation (1) and referred to it as the ARCH-M term. A
few variants have been suggested, which add standard deviation or the logarithm of the varianceinstead of variance. We will estimate the mean equations both with and without an ARCH-M
term. We use standard deviation, as it turns out that the estimations for TARCH and PARCH run
into problems when variance is used.
The variance equation takes the following form:log(V t2 ) Z ¦ E log(V )  ¦ D z
q

j 1

j

2
t j

p

i 1

i

t i

 E zt i ¦ Jz

kl 1 l t l  (2)

Here, k is the order of asymmetry, and is set equal to 1 for simplicity in the following analysis.
The parameter Ț < 0 picks up the leverage effect. Lamourex and Lastrapes [1990] suggest thatthe current turnover, denoted as TV, be added to the right-hand side of Equation (2). As it turns
out, turnover is generally highly significant when added, so we will always include it in (2) in thefollowing analyses, for omitting such a significant variable would seriously hurt the credibility of
the regression results11.
The TARCH (p, q) and PARCH (p, q) models share the same mean equation (1) with the
EGARCH (p, q), but differ in the variance equation. For the TARCH, equation (2) is replaced by:
11

Karpoff [1987], for instance, confirms a positive relationship between turnover and volatility. Theoreticalfoundations can be found in, for example, Tauchen and Pitts [1983] and Andersen [1996]. Although, if these
theories are correct, there is a concern for the problem of endogeneity, no justification can be made for dropping
turnover altogether unless proper treatment is made for the problem.

7

V t2

Z

¦ EV
q

j

j 1

2
t j 

¦ D H ¦ J H d
p

k

2
1
l 1 l t l t l2i t i

i 1

(3)

-1

Here, d is a dummy variable taking 1 when the stock price fell in the previous day and taking 0
otherwise. The parameter k indicates the order of asymmetry and is again set equal to 1. Note Ț<0 implies the existence of the leverage effect. For PARCH, equation (2) is replaced by:

V t2 Z 

¦ EV
q

j

j 1

2
t j 

¦ D H
p

i 1

i

t i

 J i H t i

G

(4)Here țis the parameter of the power term. While the asymmetry only additively enters into
the variance equation in the above two models, here it enters as mixed with a power. This can be
estimated together with other parameters. We do so in the following.
It is often argued that stock return volatility exhibits a day-of-the-week effect. That is, forexample, on Monday, it is higher than the rest of the week. In order to address this possibility, we
create day-of-the-week dummies in the following manner, and add them in the regression.

WDtk = ­® 0 if t falls on the k th day of the week , k
if otherwise¯1

1 , 2 ,... 4

Here k=1 corresponds to Monday. Note that k is 1 through 4; that is, Friday is the base line of theregression. We will try specifications both with and without this day-of-the week effect.
To examine the effect of tax reforms, we add a dummy variable representing the reform,
which takes the values of 0 and 1 before and after the date when the change was put into effect.
To examine the abolition of STT and the streamlining of the capital gains tax, we represent themby:
­0 if t d t0
Dts = ®
, s 1, 2¯1 if otherwise
We assign s=1 to the abolition of the STT in April 1999; so, t0 is March 31, 1999 for s=1. We
assign s=2 to the streamlining of the capital gains and dividend tax; so, t0 is March 31, 2003 fors=2.
To summarize, the mean equation with both ARCH-M term and the day-of-the-week effecttakes the form:Rt¦a  bRi 1  cV t2  dDts 4

k 1

f kWDtk  H t.

The variance equation with the day-of-the week effect, in the case of the EGARCH, islog(V t2 ) Z 

¦

q
j 1

 G Dts 

E j log(V t2 j ) 

¦ D z
p

i 1

¦ T WD OTV
4

k 1 k

k
t

i

t i  E

zt  i  Jzt 1.

t

The variance equations for TARCH and PARCH are defined similarly. We selectively restrict c
and all f k and ȟk, to be zero (k = 1, 2, 3, and 4). In the analysis below, we vary the values of p

8and q from 1 to 5, and examine the overall tendency to draw some implications 12 , in thefollowing four specifications:Spec. I: c = f k = ȟk = 0 (no ARCH-M or day-of-the-week effect)Spec. II: f k = ȟk = 0 (no day-of-the week effect)Spec. III: c = 0 (no ARCH-M term)Spec. IV: no restriction

3.2. Data
For return, we use daily closing prices of the Nikkei average, which covers 225 common
stocks traded in the First Section of the Tokyo Stock Exchange; R is calculated as a log
difference of the prices. We obtain TV from the same source.
The estimation period is selected to cover the longest possible period that is not affected byother relevant institutional changes, before and after the date of the concerned tax change. Thatwould make the estimation period six months before and after the reform for the abolition of the
STT, because the government completely deregulated commission fees charged to customers bysecurities companies on October 1, 1999. It is considered that the liberalization further reduced
the transaction cost. For the streamlining of the capital gains tax, the estimation period is a little
longer, from July 1, 2002 to December 31, 2004, because a law was amended to tax mutual funds
on January 1, 200413. A longer period may be preferred for both reforms, but doing so includes
other institutional changes in the estimation, making it difficult to judge whether the results are
due purely to the tax reforms in focus.

4. Estimation Results
4.1. The Abolition of STT in 1999
Table 2 reports the summary statistics for R, and Graph 2 is the graphical presentation. As
mentioned, we vary both p and q from 1 to 5 for each of the four specifications; so there arealtogether 100 regression results and, due to space limits, it is not possible to report the detailed

12

Alternatively, one can choose a specific value for each value of p and q, based on AIC or some otherinformation criteria. However, we did not take that approach because AIC did not vary enough with thisparticular data to allow for any meaningful considerations.
13
As of January 1, 2004, the proceeds from mutual funds are treated as equivalent of stock dividends rather thaninterest receipts from bonds and bank deposits.

9results of all regressions in full. Therefore, we only report the estimated coefficients, d, of ourprimary interest, Ds, and the associated levels of significance14.

Table 2: Summary statistics for stock return: Oct. 1, 1998 to Sep. 30, 1999
Mean
0.001196
Minimum-0.05957
Median0.000812
Standard Dev.
0.01556
Maximum
0.05991
No. of observations
246(Note) Stock return is calculated as a log difference of the daily closing price of the Nikkei
average stock price.

Graph 2: Stock return movement: Oct. 1, 1998 to Sep. 30, 1999
0.06
0.05
0.04
Tax Change

0.03
0.02
0.01
0
 0.01
 0.02
 0.03
 0.04(Note) See the note for Table 2.

Table 3 reports the results for EGARCH. In observing it, one should note that the coefficientsare all of negative sign across the four specifications. In terms of significance, in almost all cases,
the coefficients are significant at least at the 10% level; there are many cases where they are soeven at the 1% level. These tendencies are strongest in Spec III. These results are suggestive thatthe tax reform in 1999 decreased, rather than increased, return volatility.

Table 3: Summary of results for STT abolition in 1999 (EGARCH)
Spec I

p

14

1
2
3
4
5

q
1
-0.670**-0.911***-0.912***-0.833***-0.846***2-0.672***-0.882***-0.878***-0.765**-0.873***

3-0.170**-0.866**-0.861**-0.832**-0.377**

4-0.235**-0.243-0.224-0.649**-0.399*5-0.278**-0.778**-0.330**-0.347*-0.275*

Following Bollerslev, Engle and Nelson [1994], we specify the distribution of z by student’s t distribution.

10

Spec II
1
2
3
4
5Spec III

p

1
2
3
4
5
Spec IV

p

p

1
2
3
4
5

q
1
-0.824***-0.882***-0.872***-0.815***-0.798***2-0.785***-0.712***-0.781**-0.744**-0.783**1-0.875**-1.041***-1.022***-1.211***-1.109***2-0.919***-1.042***-1.007***-1.259***-1.128***1-1.101***-1.065***-1.031***-1.121***-1.081***2-1.216***-1.022***-1.005***-1.092***-1.120***3-0.132*-0.405*-0.655***-0.854**-0.623*q
3-0.263**-0.829**-0.839**-0.902**-0.677***q
3-0.240*-0.871***-0.885***-0.751***-0.7094-0.236**-0.995**-0.221-0.461**-0.738*5-0.287**-0.333*-0.620*-0.641**-0.292***

4-0.264*-0.862**-0.887**-0.888***-0.790***5-0.839**-0.751**-0.809**-0.735**-0.650**4-0.643*-0.926**-0.916**-0.848*-0.736

5-0.447*-0.781**-0.766**-0.804*-0.791**

Note: The value in each entry is the coefficient for the tax reform dummy, D, in the variance equation. One, two,and three asterisks mean that the estimated coefficient is significant at the 10%, 5%, and 1% levels, respectively.

Table 4 reports the results for TARCH. The tendencies observed in Table 3 are more or lessevident here too. The coefficients are negative in all cases, and significant in many cases. One
may say that evidence of the negative effect of the tax reform on volatility is a little weaker,
because there are more cases of an insignificant coefficient. While that may be true, in ourjudgement the evidence is firm enough to conclude that the tax reform reduced volatility or atleast to reject the hypothesis that the reform increased it.

Table 4: Summary of results for STT abolition in 1999 (TARCH)
Spec I

p

q
1

2

3

4

5

-1.38E-05***-1.97E-05**-3.20E-05***-4.37E-05**-5.29E-05***2-1.10E-05**-1.88E-05**-3.71E-05***-5.05E-05***-4.40E-05**

3-0.000164***--3.88E-05***-4.60E-05***-5.51E-05***

4-0.000161***-0.000138***-7.17E-09-5.55E-05**-8.78E-09

5-6.37E-05-7.08E-09-7.84E-09-8.66E-09-4.93E-05***

5

1Spec II

p

q
1

2

3

4

1

-9.31E-05**-1.90E-05*-4.20E-05***-3.84E-05***-4.16E-05***2-1.12E-05**-1.15E-05-6.22E-06-1.56E-05-6.79E-05***11

3-1.30E-05*-1.64E-05-3.68E-05****-2.04E-05*-5.70E-05***

4-6.58E-05*-7.24E-05*-6.38E-09-7.06E-09-5.02E-05***5-5.67E-09-6.32E-09-5.09E-05*-4.71E-05-1.27E-05

Spec III

p

q
1

2

3

4

5

1

-4.64E-05***-4.69E-05**-5.40E-05***-5.43E-05**-6.35E-05***2-0.000149***-7.57E-05***-5.05E-05***-5.37E-05***-6.50E-05***

3-0.000154***-0.000160***-6.81E-05***-5.79E-05***-1.70E-08

4-0.000128***-8.31E-05***-5.86E-05***-1.68E-08-1.79E-08

5-0.000114**-8.59E-05**-7.29E-05***-8.29E-05**-7.31E-05**

5

Spec IV

p

q
1

2

3

4

1

-6.50E-05**-6.75E-05***-4.84E-05***-3.72E-05**-4.79E-05**

2-2.67E-05**-3.69E-05**-2.44E-05*-3.66E-05*-5.10E-05***3-1.93E-05***-2.40E-05*-1.28E-08-1.37E-08-1.46E-08

4-2.46E-05***-1.35E-08-1.45E-08-4.44E-05***-4.44E-05***5-1.25E-08-1.34E-08-3.82E-05***-2.77E-05***-3.47E-05***

Note: The value in each entry is the coefficient for the tax reform dummy, D, in the variance equation. One, two,and three asterisks mean that the estimated coefficient is significant at the 10%, 5%, and 1% levels, respectively.

Finally, the results for PARCH are reported in Table 5. The evidence for the negative effect of
the tax reform on volatility is weakest of all. That is particularly so in the estimation without the
day-of-the-week ettect (Spec I and II); there are only a few cases when the estimated coefficientsare significant even at the 10% level. However, note that even in the cases of insignificant
coefficients, their signs are all negative. In the estimation with the day-of-the week effect (SpecIII and IV), there are more cases for significant coefficients. They are all of the negative signwhether significant or not.

Table 5: Summary of results for STT abolition in 1999 (PARCH)
Spec I

p

q
1

2

3

4

5

1

-5.90E-06-8.51E-06-7.20E-06-2.13E-05**-3.71E-05**

2-7.57E06-1.18E-05-8.46E-06**-2.79E-05***-4.93E-05***

3-8.66E-05-4.21E-05*-4.48E-05-8.27E-11-9.10E-11

4-6.65E-11-0.000166-1.35E-05-8.97E-11-9.84E-11

5-7.28E-11-8.03E-11-8.84E-11-4.64E-05-4.23E-05***

Spec II

p

㹯
1

2

3

4

5

1

-1.41E-11-6.87E-06-1.21E-05-6.70E-06**-1.44E-05***2-1.02E-05-1.36E-05-1.84E-05-8.35E-06-1.66E-05

3-2.09E-05-1.68E-05-1.59E-05-1.30E-05-8.03E-1112

4-7.30E-05-6.07E-05-7.22E-11-7.95E-11

2.76E-05

5-6.46E-11-7.15E-11-6.07E-05-6.04E-05-1.08E-05

Spec III

p

q
1

2

3

4

5

1

-3.93E-05**-4.80E-05***-4.03E-05***-3.09E-05***-6.51E-05

2-5.03E-05***-5.62E-05***-3.47E-05-4.34E-05**-6.45E-05**

3-0.000108-7.91E-05***-5.71E-05**-6.91E-05***-6.09E-05**

4-9.12E-05***-9.01E-05-1.72E-10-1.82E-10-5.14E-05***5-1.60E-10-1.69E-10-6.50E-05-5.95E-05-7.72E-05**

Spec IV

p

q
1

2

3

4

5

1

-2.97E-05***-1.95E-05***-6.56E-05***-1.73E-05***-3.48E-05

2-1.41E-05-2.50E-05-2.99E-05

2.80E-05-2.52E-05***3-1.98E-05-2.75E-05***-2.05E-05***-2.76E-05-1.59E-10

4-3.22E-05-3.03E-05***-1.48E-10-1.58E-10-2.48E-05*

5-1.37E-10-4.66E-05-6.57E-05-1.11E-05*-4.36E-05*

Note: The value in each entry is the coefficient for the tax reform dummy, D, in the variance equation. One, two,and three asterisks mean that the estimated coefficient is significant at the 10%, 5%, and 1% levels, respectively.

Overall, the conclusion one can draw from these results would be: there is firm evidence thatthe 1999 tax reform reduced volatility. The strength of evidence for this case varies somewhat
among the three estimation models, but they are unanimous in rejecting the hypothesis that thevolatility is increased, as the coefficients are negative in all cases. This conclusion is in line withthose of the previous studies based on the traditional concept of historical volatility.

4.2. The Tax Reform in 2003
We conduct the analysis similarly for the streamlining of the capital gains tax in 2003. Table 6
reports the summary statistics for R, and Graph 3 is the graphical presentation. Tables 7 through9, as before, report the coefficient Ds and their associated levels of significance for each of thethree estimation models.

Table 6: Summary statistics for stock return: Jul. 1, 2003 to Dec. 31, 2004
Mean
0.000014
Minimum-0.052258
Median0.000081
Standard Dev.
0.015188
Maximum
0.035373
No. of observations
371(Note) Stock return is calculated as a log difference of the daily closing price of the Nikkei
average stock price.

13

Graph 3: Stock return movement: Oct. 1, 1998 to Sep. 30, 1999
0.04
0.03
TaxChange

0.02
0.01
0
0.01
0.02
0.03
0.04
0.05

(Note) See the note for Table 2.

First, let us look at the results for EGARCH in Table 7. One can observe that again the signsof the coefficients are all negative. In terms of significance, in almost all cases across the four
specifications, the coefficients are significant at least at the 10% level; many are so even at the
1% level. Therefore, one can draw a similar conclusion to that of the previous section: the tax
reform in 2003 contributed to the reduction of return volatility. This is also in line with theprevious studies. It especially compares to the results of Noronha and Ferris [1992], who used the
traditional concept of historical volatility to address the issue of tax reform and return volatility.

Table 7: Summary of estimation results for capital gains tax reform in 2003 (EGARCH)
Spec I
1
p

1

2

3

4

5

-0.507*-0.560*-0.462-0.582*-0.5362-0.522-0.639*-0.202***-0.585*-0.138***3-0.101***-0.141***-0.168***-0.165**-0.172***

4-0.476-0.182***-0.248***-0.176***-0.198***5-0.089***-0.183***-0.219***-0.198**-0.238**

1

2

3

4

5

1

-0.580*-0.753**-0.581*-0.600*-0.571*2-0.606*-0.794**-0.648*-0.632*-0.713*3-0.657**-0.175***-0.217***-0.200***-0.221***

4-0.612*-0.176***-0.231***-0.216***-0.221***5-0.458-0.177***-0.229***-0.236***-0.294***

1

2

4

5

Spec
II

Spec
III
p

q

q

q
3

1

-0.679**-0.828**-0.692*-0.596-0.618*2-0.711**-0.916**-0.869*-0.679-0.6343-0.741**-0.153***-0.194***-0.166**-0.176**14

4-0.719**-0.167***-0.212***-0.198***-0.187***5-0.703**-0.163***-0.209***-0.241***-0.560*

1

2

3

4

5

Spec
IV
p

q

1

-0.705***-0.851**-0.888**-0.643*-0.717*2-0.726**-0.884**-0.992**-0.682*-0.650*3-0.769**-0.899**-0.642*-0.352***-0.637*

4-0.768**-0.609-0.544*-0.650*-0.495*

5-0.792**-0.605*-0.614*-0.586*-0.568**sNote: The value in each entry is the estimated coefficient for the tax reform dummy, D , in the variance equation(2). One, two, and three asterisks mean that the estimated coefficient is significant at the 10%, 5%, and 1% levels,
respectively.

Table 8 contains the results for TARCH. The evidence for the tax reform reducing volatility issomewhat weaker than for EGARCH. This is particularly evident in the most restrictive model,
Spec I. There are only three cases where the coefficient is significant. However, in the other threemodels, there are many more significant coefficients. In the least restrictive model, with the
ARCH-M term and the-day-of-the-week effect, Spec IV, there is only one case where thecoefficient is insignificant at the 10% level. In fact, they are significant at the 1% level in 18 outof 25 cases. In all 100 cases, the signs are negative. Therefore, it is reasonable to read theseresults as indicating that the volatility is reduced, certainly not increased, by the tax reform.

Table 8: Summary of estimation results for capital gains tax reform in 2003 (TARCH)
Spec I

p

1

2

3

4

5

1

-8.73E-05*-5.54 E-05*-8.02 E-05

-1.07 E-05

-5.78 E-05

2

-4.48 E-05

-4.95 E-05

-5.05 E-05

-5.03 E-05

-5.25 E-05

3-4.80 E-05

-6.53 E-05**-5.77 E-05

-5.41 E-05

-5.72 E-05

4-5.77 E-05

-5.83 E-05

-5.68 E-05

-5.37 E-05

-5.87 E-05

5-4.77 E-05

-5.25 E-05

-5.35 E-05

-0.000105***-4.63 E-05

1

2

4

5

-6.35 E-05***-5.45 E-05**-4.65 E-05**-7.11 E-05***2-5.61 E-05**-5.43 E-05***-8.48 E-05***-6.29 E-05**-6.42 E-05**

3-7.49 E-05***-8.17 E-05***-6.13 E-05***-7.11 E-05

-6.04 E-05

4

-7.54 E-05

-8.24 E-05**-6.88 E-05

-6.66 E-05

-7.97 E-05**

5-6.32 E-05

-7.17 E-05**-6.15 E-05**-7.40 E-05***-6.67 E-05

1

2

3

4

5

Spec
II
1
p

Spec
III
p

q

q
3
-5.50E-05**q1-5.33 E-05**-7.25 E-05***-7.20 E-05*-6.67 E-05***-7.32 E-05***2-6.26 E-05

-5.47 E-05

-7.12 E-05**-7.54 E-05**-7.36 E-05***3-8.31 E-05***-8.12 E-05*-7.71 E-05

-6.79 E-05

-8.52 E-05***

4-7.30 E-05

-4.91 E-05

-8.63 E-05***-6.92 E-05***-7.94 E-05***

15

5
Spec
IV
p

-6.94 E-05

-3.15 E-05

-3.93 E-05

-7.13 E-05

-5.34 E-05

q
1

2

3

4

5

1

-5.84 E-05***-6.40 E-05**-7.25 E-05***-6.03 E-05

-6.86 E-05***2-6.81 E-05***-9.97 E-05***-6.58 E-05**-7.53 E-05***-7.45 E-05***3-8.17 E-05***-7.96 E-05***-7.37 E-05***-5.53 E-05***-7.80 E-05*

4-8.12 E-05**-8.47 E-05***-7.02 E-05***-8.08 E-05**-7.13 E-05***

5-7.11 E-05***-7.73 E-05***-8.11 E-05***-7.43 E-05***-7.83 E-05**s

Note: The value in each entry is the estimated coefficient for the tax reform dummy, D , in the variance equation(2). One, two, and three asterisks mean that the estimated coefficient is significant at the 10%, 5%, and 1% levels,
respectively.

Finally, Table 9 reports the results for PARCH. The evidence for the reduced volatility is
weakest. In the most restrictive model of Spec I, no significant coefficient is obtained. The
evidence is weaker in the other specifications even compared with TARCH. Looking at this table
alone, one may conclude that there is only weak evidence that the tax reform reduced volatility.
However, the hypothesis that the volatility is increased can be strongly rejected as there is no
single case where the coefficient is of the positive sign.

Table 9: Summary of estimation results for capital gains tax reform in 2003 (PARCH)
Spec I

p

q
1

2

3

4

5

1

-4.47 E-05

-6.61 E-05

-4.35 E-05

-6.49 E-05

-4.53 E-05

2

-4.67 E-05

-5.22 E-05

-5.09 E-05

-5.92 E-05

-5.47 E-05

3-6.01 E-05

-6.01 E-05

-6.38 E-05

-5.82 E-05

-5.87 E-05

4

-6.15 E-05

-6.23 E-05

-5.99 E-05

-7.61 E-05

-6.32 E-05

5-7.47 E-05

-4.66 E-05*-6.57 E-05

-5.60 E-05

-3.32 E-05

Spec II

p

1

2

3

4

5

1

-3.72 E-05**-4.62 E-05**-5.03 E-05*-4.69 E-05**-6.13 E-05***2-4.94 E-05*-6.03 E-05**-7.12 E-05

-4.58 E-05

-5.17 E-05***3-1.24 E-11

-6.00 E-05**-6.93 E-05***-5.64 E-05**-6.62 E-05

4-7.26 E-05

-7.26 E-05***-8.05 E-05*-7.52 E-05

-9.26 E-05

5-6.69 E-05

-6.81 E-05**-6.19 E-05

-7.90 E-05**-8.00 E-05**

Spec
III
p

q

q
1

2

3

4

5

1

-4.36 E-05*-4.53 E-05

-5.69 E-05

-2.91 E-11

-6.42 E-05

2

-6.21 E-05

-6.06 E-05

-7.60 E-05***

3-7.66 E-05***-7.65 E-05

-9.14 E-05***-7.40 E-05

-6.87 E-05

40.000108***-8.60 E-05

-9.63 E-05***-8.54 E-05**-8.88 E-05***

5-7.03 E-05

-7.03 E-05

-7.19 E-05

-7.19 E-05

-9.05 E-05

4

5

Spec
IV

-6.75 E-05

-6.31 E-05

q
1

2

3

16

p

1

-4.94 E-05**-6.73 E-05

-6.58 E-05***-4.98 E-05**-6.15 E-05

2

-6.53 E-05**-7.20 E-05***-7.60 E-05

-6.86 E-05

-6.34 E-05***3-6.64 E-05***-8.65 E-05***-5.77 E-05**-6.77 E-05**-8.03 E-05***

4-6.71 E-05***-8.89 E-05***-7.70 E-05***-7.77 E-05

-6.52 E-05**

5-7.71 E-05***-6.74 E-05

-7.46 E-05***-9.12 E-05

-8.36 E-05

s

Note: The value in each entry is the estimated coefficient for the tax reform dummy, D , in the variance equation(2). One, two, and three asterisks mean that the estimated coefficient is significant at the 10%, 5%, and 1% levels,
respectively.

5. Conclusions
Whether taxation of stock trading contributes to or aggravates the stability of the market has along history in policy-making debates as well as academic discourse. Earlier studies on thesubject seem to suggest that taxes do not increase return volatility, but rather decrease it. Thesestudies, however, use the concept of historical volatility and do not take advantage of recent
advances in modeling return volatility. In view of this, this paper revisits the issue by employing
variants of the GARCH type model that incorporate the widely observed asymmetry in the
behavior of stock return volatility known as the leverage effect, namely EGARCH, TARCH and
PARCH models. To do so, the paper exploits the recent tax reforms in Japan, which are thought
to have decreased transaction cost considerably.
We examined the dummy variable, representing the two tax reforms, in the variance equation
for four different specifications varying the ARCH orders of (p, q) in each of the three models.
The estimation yields more or less similar results for both tax reforms. The results for EGARCH
constitute firm evidence to support the view that the tax reform reduced volatility. Those for
TARCH and PARCH are somewhat weaker as such evidence, but are strong enough to draw theabove conclusion when viewed in total. The hypothesis that the tax change increased volatility isstrongly rejected because the sign of the coefficient is negative literally in all of the 600 cases
across models and specifications. These results are in line with earlier findings based on theconcept of historical volatility.
At the end of the paper, it may be worth mentioning the shortcomings of the present analysis
and venues for future extension. First, this paper used variants of GARCH type models. Whilethese models are relatively new, other concepts of volatility have been suggested more recently inthe finance literature, such as stochastic volatility and realized volatility. Therefore, further
investigation of the issue using the most recent developments in the literature may be aninteresting line of future research. This paper also focuses on Japan, but many other countries still
hold a turnover tax and other related taxes. These include growing economies in East Asia15.
Examining the experiences of those countries, thereby bringing a broader perspective, would be
15

Examples include South Korea, Singapore, Hong Kong, Taiwan and China.

17beneficial in quest of appropriate policies for taxation of stock trading in this age of globalization,
especially in a time of recurrent interest in financial taxation.

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19