A Laboratory Study of Price Formation and Learning in Auction Markets

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How do self-interested traders with private information arrive at equilibrium prices for market exchange? This question of price formation has always been central to economic theory. The question is also crucial in practical applications because many policy interventions (ranging from job retraining programs to SEC reporting requirements in securities markets) are intended to influence the adjustment to equilibrium and therefore their effectiveness depends entirely on the price formation process. Unfortunately, the underlying price formation process is still not well understood, despite centuries of theoretical debate and crucial practical implications. This project conducts four sets of laboratory experiments designed to shed new light on the price formation process. One set employs the Continuous Double Auction (CDA) market institution, which is known to promote exceptionally rapid and reliable price formation in the laboratory. A second set of experiments employs the Single Call Market (SCM), less commonly seen in the field and less efficient in the laboratory but better understood theoretically than the CDA. The other sets of experiments examine intermediate trading institutions called the Multiple Call Market (MCM) and the Uniform Price Double Auction (UPDA). This project provides new empirical evidence on price formation process by addressing two major shortcomings in existing laboratory data. First, almost all market experiments are repetitively stationary (or use fixed additive shifts), so equilibrium price remains constant (or shifts in lockstep) across trading periods. Such an experiment provides only a single observation of price formation, spread across several trading periods. The proposed experiments incorporates random values - private cost and value parameters drawn independently each period from announced uniform distributions. Second, although it is clear that the price formation process depends crucially on the market institutions, the institutional variations in most experiments are insufficient to identify why and how market institutions matter. The proposed experiments incorporate wide institutional variations. Data analysis will be used to test the three promising theoretical approaches found in recent literature to understanding price formation.