EconPort - Double Auction

Double Auction Market

Background

In one of the earliest market experiments, Chamberlin [1948] conducted a classroom trading exercise that was designed as a test of the competitive model. In Chamberlin's experiment, some students were buyers who received a card with a unit value written on it, and others were sellers who received a card with a unit cost written on it. Students then walked about the room, and buyers and sellers could negotiate over the terms of trade. When a deal was struck, the price that the students agreed to was written on the blackboard. This test produced trade volumes in excess of the competitive equilibrium price, and trade prices that were quite variable. It occurred to Vernon Smith, who had seen this classroom exercise as a graduate student at Harvard in the early 1950's, that this experiment could be redesigned with bidding rules similar to those used in organized equity markets. In important experimental tests, Smith [1962, 1964] centrally and publicly recorded all bids and offers, instead of allowing traders to mingle in the room and haggle over prices as in Chamberlin's experiment. This modification to the trading rules, which is known as a double auction since both buyers and sellers are active, leads quickly and accurately to the predictions of the competitive market model.

As described by Smith [1982], these experiments provide an important insights into the competitive model. Experiments using the double auction institution converge reliably to the competitive price even with as few as three or four sellers, and neither the buyers nor the sellers need to have information about the values or costs of others in the market. These experiments also demonstrate that price-taking behavior is not a necessary assumption to reach the prediction of the competitive model, since every seller actively chooses his asks and which bids to accept, and every buyer chooses bids and which asks to accept.

Operation

The double auction is a simple and very effective trading institution. Figure 1 below shows a typical seller screen from a double auction commodity market experiment. A buyer's screen for this experiment is very similar.

Figure 1: Double auction seller's screen

In the double auction, any seller may submit an ask at any time during a trading period. A typical double auction trading screen is shown below. An ask is entered in the area labelled ``Enter Ask" on this seller's screen display. This ask represents the seller's current report of the lowest price that he is willing to accept for a unit of some commodity or security. Similarly, buyers may submit a bid at any time, which represents the buyer's current report of the highest price that she is willing to pay for a unit of the commodity. If an ask is placed that is at or below the current high bid, a trade results. Similarly, if a bid is placed that meets or exceeds the current low ask, a trade occurs. A seller may make any number of asks and may trade any number of units, provided that he has the units available to sell. Similarly, a buyer may make any number of bids, and may trade any number of units provided that she has the currency to complete the purchases.

Throughout each trading period, a queue on the screen of each seller displays all current asks and bids (shown as the "Market Queue" in figure 1; the screen of each buyer also displays both queues. When a seller successfully enters an ask into the ask queue, his ask appears in the "Unit Ask" row of the "Trade Summary" table, in the column that corresponds to the unit the seller has offered for sale. Similarly, a buyer sees an update to the appropriate cell in her Trade Summary table when she enters a bid into the bid queue.

When a seller and buyer complete a trade, each one sees the "Unit Price" recorded in their Trade Summary table, and the price is included in a graphical display of all trade prices from the current period, shown as the ``Market Transaction Prices'' graph. The length of each trading period is known to each seller and to each buyer, and a clock on the screen of each seller and buyer shows the time remaining in the period.

The double auction example above includes several key elements, such as entry of asks, the ask and bid queues, and a trade execution rule. Many variants of the double auction have been used in experiments, and also in equity markets such as NASDAQ. There is no single, standard form for the double auction, but almost all variants share a few characteristics. There are both ask prices and bid prices submitted, trading takes places continuously over an interval of time, and trades occur when a buyer's bid is at or above a seller's ask, or a seller's ask is at or below a buyer's bid. Aside from these few general characteristics, many specific rules have been tried.

Double auction experiments

Double auction experiments are included in MarketLink for several models, including a competitive market, a duopoly market, a monopoly market, and an asset market. If you haven't yet used MarketLink to run an experiment, go to the MarketLink page for information. If you are familiar with MarketLink, you can add these experiments to you profile from the links below.

References

Chamberlin, Edward H. (1948). "An Experimental Imperfect Market," Journal of Political Economy, 56:2, pp. 95-108.

Smith, Vernon L. (1962), "An Experimental Study of Competitive Market Behavior," Journal of Political Economy, 70:2, pp. 111-137.

Smith, Vernon L. (1964), "Effect of Market Organization on Competitive Equilibrium," Quarterly Journal of Economics, 78:2, pp. 181-201.

Smith, Vernon L. (1982). "Markets as Economizers of Information: Experimental Examination of the 'Hayek Hypothesis'," Economic Inquiry, 20:2, pp. 165-79.