Bubbles, Crashes and Efficiency with Double Auction Mechanisms

Abstract

We provide two novel dynamic double auction (DA) mechanisms for a class of economies and study their convergence property to competitive equilibrium. For DA mechanisms, we find a parameter on the two sequences of the marginal bid increments (bid step-size) and ask decrements (ask step-size) that is important for the two mechanisms to reach an equilibrium. For an economy selling multiple identical copies of a single asset, this parameter  steers the price process generated by the two mechanisms to equilibrium, bubble or crash. Our study provides evidence in theory that shows that the double auction, as a trading institution, may not be so efficient as what has been claimed by the efficient markets hypothesis (EMH). The source of inefficiency comes from the o -balance in the two sequences of the marginal bid increments and ask decrements. Such o -balance shifts total demand and supply curves of the original economy and is seized by this parameter  in a subtle manner. We also show that bounded stochastic noise or irrationality in orders cannot distort the two mechanisms from reaching equilibrium. Therefore, our study is important for both EMH and the study of behavioral finance.