Abstract
AbstractMarkets have an exposure problem when getting to the optimal allocation requires a sequence of transactions which if started but not completed leaves at least one trader with losses. We use laboratory experiments to evaluate the effect of the exposure problem on alternative market mechanisms. The continuous double auction performs poorly: efficiency is only 20% when exposure is high and 55% when it is low. A package market effectively eliminates the exposure problem: in low and high-exposure treatments efficiency is 82% and 89%, respectively. Building on stability notions from matching theory we introduce the concept of mechanism stability. A model of trade that combines mechanism stability with noisy best responses and imperfect foresight explains the difference in market performance. Finally, decentralized bargaining with contingent contracts performs well with perfect information and communication but not in the more realistic case when traders’ preferences are privately known.
Highlights
Monetary theorists since at least Jevons have recognized how using money as a medium of exchange can facilitate trade
The goal of this paper is to examine how different market mechanisms perform in reassignment problems when exposure is present
We discuss in detail how exposure affects the continuous double auction
Summary
Monetary theorists since at least Jevons have recognized how using money as a medium of exchange can facilitate trade. The double coincidence of wants problem that occurs in barter can be solved by letting traders arrive at their desired allocation of goods via a series of bilateral transactions involving money. Even if it were certain that subsequent trades will occur, the initial trade may weaken the agent’s bargaining position to the extent that the loss cannot be recouped. While the introduction of money solves Jevons’ double coincidence of wants problem it does not protect traders from being exposed to losses. Anticipating this exposure problem, traders may be unwilling to make the first trade leaving potential gains from trade unrealized
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