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Convergence to Efficiency in a Simple Market with Incomplete Information

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  • Aldo Rustichini

Abstract

An independent private values model of trade with m buyers and m sellers is considered in which a double auction sets price to equate revealed demand and supply. In a symmetric Bayesian Nash equilibrium, each trader acts not as a price-taker, but instead strategically misrepresents his true demand/supply to influence price in his favor. This causes inefficiency. We show that the amount by which a trader misreports is 0(1/m) and the corresponding inefficiency is 0(1/m^2). By comparison, inefficiency is 0(1/m) for a dual price mechanism and 0(1/m^1/2) for a fixed price mechanism. Price-taking behavior and its associated efficiency thus quickly emerge in the double auction despite the asymmetric information and the noncooperative behavior of traders.

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  • Aldo Rustichini, 1992. "Convergence to Efficiency in a Simple Market with Incomplete Information," Discussion Papers 995, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  • Handle: RePEc:nwu:cmsems:995
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    1. Holmstrom, Bengt & Myerson, Roger B, 1983. "Efficient and Durable Decision Rules with Incomplete Information," Econometrica, Econometric Society, vol. 51(6), pages 1799-1819, November.
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