  This paper investigates - on the basis of the Cont-Bouchaud model - whether a
Tobin tax can stabilize foreign exchange markets. Compared to earlier studies,
this paper explicitly recognizes that a transaction tax-induced reduction in
market depth may increase the price responsiveness of a given order. We find
that the imposition of a transaction tax may still achieve a triple dividend:
(1) exchange rate fluctuations decrease, (2) currencies are less mispriced, and
(3) central authorities raise substantial tax revenues. However, if the price
impact function is too sensitive with respect to market depth, stabilization
may turn into destabilization.
