This paper analyzes the effects of a change in the transactions tax rate on stock market behavior in an emerging market.  We expect that a tax rate increase would cause a decrease in trading volume and an increase in market volatility. In addition, a modified GARCH model is applied to show that the market becomes less efficient in the sense that shocks are less quickly assimilated in the market. Using daily data from the Chinese stock markets for 1993- 2008, during which there were 12 tax rate changes, we find some consistent explanations of the transactions tax’s effects on the stock markets.

Our study has an important implication for emerging capital markets, which is that the transaction tax cannot be used as a tool to stabilize market.