Price formation in double auction markets

Abstract This paper reports 14 laboratory experiments that examine existing theories of the price formation process in the continuous double auction. The experiments feature random values and costs, and therefore a new price formation observation each period. We find that efficiency is high and rises with experience in this environment. We also find that trades with greater exchange surplus tend to occur earlier in the period, that increased trader experience reduces an anomalous intertemporal arbitrage opportunity observed previously, and that only when traders are very experienced does exchange surplus accrue disproportionately to the side of the market with a smaller number of traders.

[1]  E. Fama.  EFFICIENT CAPITAL MARKETS: A REVIEW OF THEORY AND EMPIRICAL WORK* , 1970 .

[2]  Daniel Friedman,et al.  Competitivity in Auction Markets: An Experimental and Theoretical Investigation , 1995 .

[3]  Vernon L. Smith.  Papers in Experimental Economics: An Experimental Study of Competitive Market Behavior , 1962 .

[4]  V. Smith.  Microeconomic Systems as an Experimental Science , 1982 .

[5]  Dhananjay K. Gode,et al.  Allocative Efficiency of Markets with Zero-Intelligence Traders: Market as a Partial Substitute for Individual Rationality , 1993, Journal of Political Economy.

[6]  D. Friedman.  On the Efficiency of Experimental Double Auction Markets , 1984 .

[7]  Nathaniel T. Wilcox,et al.  Avoidable Cost: Ride a Double Auction Roller Coaster , 1996 .

[8]  Charles R. Plott,et al.  A Computerized Laboratory Market System and Research Support Systems for the Multiple Unit Double Auction , 1991 .

[9]  J. Ledyard,et al.  Theories of price formation and exchange in double oral auctions , 1986 .

[10]  J. Kagel.  7. Auctions: A Survey of Experimental Research , 1995 .

[11]  V. Smith.  An Experimental Study of Competitive Market Behavior , 1962, Journal of Political Economy.

[12]  Robert B. Wilson.  On Equilibria of Bid-Ask Markets , 1987 .

[13]  V. Smith,et al.  The effects of rent asymmetries in experimental auction markets , 1982 .

[14]  D. Friedman.  A simple testable model of double auction markets , 1991 .

[15]  J. Kagel,et al.  Handbook of Experimental Economics , 1997 .

[16]  G. R. Feiwel.  Arrow and the ascent of modern economic theory , 1987 .

[17]  Vernon L. Smith,et al.  Cyclical Double-Auction Markets with and without Speculators , 1984 .

[18]  Daniel Friedman,et al.  HOW TRADING INSTITUTIONS AFFECT FINANCIAL MARKET PERFORMANCE: SOME LABORATORY EVIDENCE , 1993 .

[19]  Daniel Friedman,et al.  The Effect of Sequential Information Arrival on Asset Prices: An Experimental Study , 1987 .

[20]  John Rust,et al.  The Double Auction Market , 1989 .

[21]  Vernon L. Smith,et al.  A Comparison of Posted-Offer and Double-Auction Pricing Institutions , 1984 .