Experimental evidence on trading behavior, market efficiency and price formation in double auctions with unknown trading duration

The reasons for the highly efficient market outcomes observed under the double auction remain unclear. This paper presents a series of experimental financial markets designed to investigate the importance of unknown trading period duration on trading behavior and the convergence tendencies of such markets. Using panel data techniques the results support the conclusions that individuals generally display more aggressive trading strategies, trading earlier in a period, and that markets exhibit reduced levels of informational efficiency when unknown duration is present. Markets with imperfect information structures are also studied and, in a unique result, are associated with significantly slower rates of trade, as traders become more cautious over their trading strategies. Investigation of the price formation process provides evidence that the pricing error varies over time and the estimation of a fixed effects model provides unique support that learning effects and unknown trading period duration influence the price formation process. Future refinement of theoretical models of the price formation process or institutions of exchange should recognize the effect of unknown trading period duration on market behavior, along with potential learning effects. Copyright © 2005 John Wiley & Sons, Ltd.

[1]  S. Sunder.  Experimental Asset Markets: A Survey , 1992 .

[2]  Lucy F. Ackert,et al.  Market behavior in the presence of costly, imperfect information: Experimental evidence , 1997 .

[3]  C. Plott,et al.  Efficiency of Experimental Security Markets with Insider Information: An Application of Rational-Expectations Models , 1982, Journal of Political Economy.

[4]  J. Dickhaut,et al.  Price Formation in Double Auctions , 1998 .

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

[6]  Timothy N. Cason,et al.  The Opportunity for Conspiracy in Asset Markets Organized with Dealer Intermediaries , 1999 .

[7]  Vernon L. Smith,et al.  Papers in experimental economics , 1991 .

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

[9]  Russell J. Lundholm,et al.  Information Aggregation in an Experimental Market. , 1990 .

[10]  D. Duxbury.  EXPERIMENTAL ASSET MARKETS WITHIN FINANCE , 1995 .

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

[12]  C. Plott,et al.  Rational Expectations and the Aggregation of Diverse Information in Laboratory Security Markets , 1988 .

[13]  J. Hagel,et al.  Net gain: Expanding markets through virtual communities , 1999 .

[14]  Charles R. Schnitzlein.  Price Formation and Market Quality When the Number and Presence of Insiders Is Unknown , 2002 .

[15]  T. Palfrey,et al.  Futures Markets and Informational Efficiency: A Laboratory Examination , 1984 .

[16]  James S. Ang,et al.  Risk Aversion and Information Structure: An Experimental Study of Price Variability in the Securities Markets , 1985 .

[17]  Timothy N. Cason,et al.  Price formation in double auction markets , 1996 .

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

[19]  J. Banks.  Price-conveyed Information versus Observed Insider Behavior: A Note on Rational Expectations Convergence , 1985, Journal of Political Economy.

[20]  R. Engle,et al.  Time and the Price Impact of a Trade , 1999 .

[21]  Lucy F. Ackert,et al.  An Experimental Study of Circuit Breakers: The Effects of Mandated Market Closures and Temporary Halts on Market Behavior , 2001 .

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

[23]  S. Sunder.  MARKET FOR INFORMATION: EXPERIMENTAL EVIDENCE' , 1992 .