Market Structure, Informational Efficiency and Liquidity: An Experimental Comparison of Auction and Dealer Markets
48 Pages Posted: 17 Apr 1998
Date Written: February 1998
Abstract
This paper reports the results of 18 market experiments that were conducted in order to compare the call market, the continuous auction and the dealer market. The design incorporates asymmetric information but guarantees that the ex-ante quality of the private signals of all traders is identical. Therefore, the aggregation of diverse information can be analyzed in the absence of insider trading.
Single transaction prices in the call and continuous auction market are found to be much more efficient than prices in the dealer market. The latter is, however, very efficient when average prices are analyzed. Averaging the prices of a trading period largely eliminates the bid-ask spread. The conclusion is therefore that prices in a dealer market convey high quality information, but at the expense of high transaction costs. The call market, although exhibiting small pricing errors, shows a systematic tendency towards underadjustment to new information.
An analysis of market liquidity using various measures proposed in the literature shows that execution costs are lowest in the call market and highest in the dealer market. The analysis also reveals that both the trading volume and Roll's (1984) serial covariance estimator are inappropriate measures of execution costs in the present context.
The quality of the private signals traders receive influences portfolio structure but does not influence end-of-period wealth. This result is consistent with efficient price discovery in the experimental markets.
JEL Classification: C90, G14
Suggested Citation: Suggested Citation