Price Discovery Using a Double Auction
81 Pages Posted: 10 Jul 2014 Last revised: 23 Jul 2020
Date Written: July 22, 2020
We devise a tractable model to study the buyer’s bid double auction (BBDA) that allows correlated signals and interdependent values/costs. We demonstrate that simple, easily calculated equilibria exist in small markets. We prove that the incentive for strategic behavior vanishes at a O (1/η) rate where η is an index of the number of buyers and sellers. We then assume, consistent with numerical experiments and theoretical intuition, that this incentive drives trader’s strategies to their limiting values at the same O (1/η) rate. Given this assumption, we prove rates of convergence to zero of (i) the inefficiency in the allocation, and (ii) the error in the market price as an estimate of the rational expectations price. These results together with our numerical experiments suggest that strategic behavior can be inconsequential even in small markets in its effect on allocational efficiency and information aggregation.
Keywords: double auction, rational expectations, allocational efficiency, information aggregation, computation of equilibria
JEL Classification: C62, C63, C72, D44, D82, D83
Suggested Citation: Suggested Citation