Market Efficiency and the Role of Information: An Experimental Analysis

The purpose of this research is to gain additional insight concerning the highly efficient market outcomes generated under the rules of trade of the double auction, in which traders have the dual role of both buyer and seller and can simultaneously call out offers to buy and sell. It is conjectured that the experimental literature’s robust results detailing the efficiency of the double auction institution may be a product of the constant and known duration of trade incorporated in previous experimental designs. In one of the few relevant theoretical discussions Friedman (1984, p.71) suggests that the predetermined, known time at which trade will cease is one of a number of institutional features of experimental double auction markets that enhance the efficiency of observed market outcomes. Known trading duration may well be a key variable in the determination of the price formation process and the convergence to competitive equilibrium in the double auction institution. This study extends previous work by conducting a series of experiments designed to determine the importance of trading duration on the convergence tendencies of experimental asset markets governed by the rules of the double auction institution. The issue is of substantive theoretical and practical interest. The results of this study offer a number of conclusions. Aggregated across the eighteen experimental asset markets studied, transaction prices tend to exhibit convergence to competitive outcomes. Importantly, the etlect of known period duration on observed market behaviour is significant. Experimental asset markets that incorporate uncertain trading durations display more aggressive trading strategies. This is evidenced by an increase in the rate of trade relative to markets where the duration of trade varies but is known. The markets with uncertain trading durations also exhibit reduced levels of market efficiency relative to the other markets studied. The implication is clear, any future refinement of either theoretical models or institutions of exchange must explicitly recognise the effect of uncertain trading duration on market behaviour in double auctions.