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Inducing liquidity in thin financial markets through combined-value trading mechanisms

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  • Bossaerts, Peter
  • Fine, Leslie
  • Ledyard, John

Abstract

Previous experimental research has shown that thin financial markets fail to fully equilibrate, in contrast with thick markets. A specific type of market risk is conjectured to be the reason, namely, the risk of partial execution of desired portfolio rearrangements in a system of parallel, unconnected double auction markets. This market risk causes liquidity to dry up before equilibrium is reached. To verify the conjecture, we organized markets directly as a portfolio trading mechanism, allowing agents to better coordinate their orders across securities. The mechanism is an implementation of the combined-value trading (CVT) system. We present evidence that our portfolio trading mechanism facilitates equilibration to the same extent as thick markets do. Like in thick markets, the emergence of equilibrium pricing cannot be attributed to chance. Inspection of order submission and trade activity reveals that subjects manage to exploit the direct linkages between markets presented by the CVT system.
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Suggested Citation

  • Bossaerts, Peter & Fine, Leslie & Ledyard, John, 2002. "Inducing liquidity in thin financial markets through combined-value trading mechanisms," European Economic Review, Elsevier, vol. 46(9), pages 1671-1695, October.
  • Handle: RePEc:eee:eecrev:v:46:y:2002:i:9:p:1671-1695
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    References listed on IDEAS

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    1. Bossaerts, Peter & Plott, Charles, 2002. "The CAPM in thin experimental financial markets," Journal of Economic Dynamics and Control, Elsevier, vol. 26(7-8), pages 1093-1112, July.
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    3. Giovanni Cespa, 2004. "A Comparison of Stock Market Mechanisms," RAND Journal of Economics, The RAND Corporation, vol. 35(4), pages 803-824, Winter.
    4. Peter Bossaerts & Charles Plott, 2004. "Basic Principles of Asset Pricing Theory: Evidence from Large-Scale Experimental Financial Markets," Review of Finance, Springer, vol. 8(2), pages 135-169.
    5. Athanasoulis, Stefano G & Shiller, Robert J, 2000. "The Significance of the Market Portfolio," Review of Financial Studies, Society for Financial Studies, vol. 13(2), pages 301-329.
    6. Gallant, A. Ronald & Tauchen, George, 1996. "Which Moments to Match?," Econometric Theory, Cambridge University Press, vol. 12(04), pages 657-681, October.
    7. Wohl, Avi & Kandel, Shmuel, 1997. "Implications of an Index-Contingent Trading Mechanism," The Journal of Business, University of Chicago Press, vol. 70(4), pages 471-488, October.
    8. Avi Wohl, 1997. "The Feasibility of an Index-Contingent Trading Mechanism," Management Science, INFORMS, vol. 43(1), pages 112-121, January.
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    Cited by:

    1. Schellhorn, Henry, 2011. "A trading mechanism contingent on several indices," European Journal of Operational Research, Elsevier, vol. 213(3), pages 551-558, September.
    2. Shipra Agrawal & Erick Delage & Mark Peters & Zizhuo Wang & Yinyu Ye, 2009. "A Unified Framework for Dynamic Pari-Mutuel Information Market Design," Papers 0902.2429, arXiv.org.
    3. Tomomi Tanaka, 2005. "Resource allocation with spatial externalities: Experiments on land consolidation," Experimental 0511004, EconWPA.
    4. Ledyard, John & Hanson, Robin & Ishikida, Takashi, 2009. "An experimental test of combinatorial information markets," Journal of Economic Behavior & Organization, Elsevier, vol. 69(2), pages 182-189, February.
    5. Ghosh, Gaurav & Kwasnica, Anthony & Shortle, James, 2010. "A Laboratory Experiment to Compare Two Market Institutions for Emissions Trading," FCN Working Papers 18/2010, E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN).
    6. Jacob K. Goeree & Luke Lindsay, 2012. "Designing package markets to eliminate exposure risk," ECON - Working Papers 071, Department of Economics - University of Zurich.
    7. Giovanni Cespa, 2003. "A comparison of stock market mechanisms," Working Papers 50, Barcelona Graduate School of Economics.
    8. David V. Budescu & Boris Maciejovsky, 2005. "The Effect of Payoff Feedback and Information Pooling on Reasoning Errors: Evidence from Experimental Markets," Management Science, INFORMS, vol. 51(12), pages 1829-1843, December.

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