Marketmaking in the Laboratory: Does Competition Matter?

Jan Pieter Krahnen · Martin Weber

32 citations0/0 files storedExperimental Economics

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Auction Theory and Applications Financial Markets and Investment Strategies Experimental Behavioral Economics Studies

Abstract

Abstract This paper is the first experimental study of the effects of competition and adverse selection on the performance of market maker (MM-) markets. Information distribution may is either symmetric or heterogeneous. MM-markets are either monopolistic (the specialist markets), or competitive (the multi MM-market). Welfare comparisons are with respect to a continuous double auction (DA-) market. Informed subjects receive an imperfect signal of the true state of the world. We find three main results. First, competition among market makers significantly reduces the bid-ask spread, and increases transaction volume. Second, competition among market makers induces competitive undercutting, yielding net trading losses for market makers as a group in most periods. Third, from the perspective of uninformed traders, a competing MM-regime is optimal, since it minimizes their expected trading losses.

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References

1985Continuous Auctions and Insider Trading 1985Bid, ask and transaction prices in a specialist market with heterogeneously informed traders 1986Asset pricing and the bid-ask spread 1982Information, trade and common knowledge 1988Estimating the components of the bid/ask spread 1981Optimal dealer pricing under transactions and return uncertainty 1995Market microstructure theory 1996Market Microstructure Theory.

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1999Insider trading and portfolio structure in experimental asset markets with a long-lived asset 2015Revisiting Information Aggregation in Asset Markets: Reflective Learning & Market Efficiency 2017Market maker competition and price efficiency: Evidence from China 2006Market for Information and Identity Disclosure in an Experimental Open Limit Order Book

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