Individual Rationality and Market Efficiency
The demonstration by Smith  that prices and allocations quickly converge to the competitive equilibrium in the continuous double auction (CDA) was one of the first – and remains one of the most important results in experimental economics. His initial experiment, subsequent market experiments, and models of price adjustment and exchange have added considerably to our knowledge of how markets reach equilibrium, and how they respond to disruptions. Perhaps the best known model of exchange in CDA market experiments is the random behavior in the “zero-intelligence” (ZI) model by Gode and Sunder . They conclude that even without trader rationality the CDA generates efficient allocations and “convergence of transaction prices to the proximity of the theoretical equilibrium price,” provided only that agents meet their budget constraints. We demonstrate that – by any reasonable measure – prices don’t converge in their simulations. Their budget constraint requires that a buyer’s currency never exceeds her value for the commodity, which is an unnatural restriction. Their conclusion that market efficiency results from the structure of the CDA independent of traders’ profit seeking behavior rests on their claim that the constraints that they impose are a part of the market institution, but this is not so. We show that they in effect impose individual rationality, which is an aspect of agents' behavior. Researchers on learning in markets have been misled by their interpretation of the ZI simulations, with deleterious effects on the debate on market adjustment processes.
|Date of creation:||Aug 2007|
|Contact details of provider:|| Postal: Krannert Building, West Lafayette, IN 47907|
Web page: http://www.krannert.purdue.edu/programs/phd
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Daniel Friedman, 1982.
"Price Formation in Double Auction Markets,"
UCLA Economics Working Papers
278, UCLA Department of Economics.
- Gjerstad, Steven & Dickhaut, John, 1998.
"Price Formation in Double Auctions,"
Games and Economic Behavior,
Elsevier, vol. 22(1), pages 1-29, January.
- Smith, Vernon L, 1982. "Microeconomic Systems as an Experimental Science," American Economic Review, American Economic Association, vol. 72(5), pages 923-955, December.
- Evans, Dorla A, 1997. "The Role of Markets in Reducing Expected Utility Violations," Journal of Political Economy, University of Chicago Press, vol. 105(3), pages 622-636, June.
- John List, 2004.
"Testing Neoclassical Competitive Theory in Multilateral Decentralized Markets,"
Natural Field Experiments
00490, The Field Experiments Website.
- John A. List, 2004. "Testing Neoclassical Competitive Theory in Multilateral Decentralized Markets," Journal of Political Economy, University of Chicago Press, vol. 112(5), pages 1131-1156, October.
- John List, 2004. "Testing neoclassical competitive theory in multi-lateral decentralized markets," Framed Field Experiments 00176, The Field Experiments Website.
- John Conlisk, 1996. "Why Bounded Rationality?," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 669-700, June.
- Hurwicz, Leonid & Radner, Roy & Reiter, Stanley, 1975.
"A Stochastic Decentralized Resource Allocation Process: Part II,"
Econometric Society, vol. 43(3), pages 363-393, May.
- Hurwicz, Leonid & Radner, Roy & Reiter, Stanley, 1975. "A Stochastic Decentralized Resource Allocation Process: Part I," Econometrica, Econometric Society, vol. 43(2), pages 187-221, March.
- Vernon L. Smith, 1962.
"An Experimental Study of Competitive Market Behavior,"
Journal of Political Economy,
University of Chicago Press, vol. 70, pages 322-322.
- Vernon L. Smith, 1962. "An Experimental Study of Competitive Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 70, pages 111-111.
- Bosch-Domenech, A. & Silvestre, J., 1995.
"Credit Constraint in General Equilibrium: Experimental Results,"
95-07, California Davis - Institute of Governmental Affairs.
- Bosch-Domenech, Antoni & Silvestre, Joaquim, 1997. "Credit Constraints in General Equilibrium: Experimental Results," Economic Journal, Royal Economic Society, vol. 107(444), pages 1445-1464, September.
- Bosch-Domenech, A. & Silvestre, J., 1995. "Credit Constraint in General Equilibrium: Experimental Results," Department of Economics 95-07, California Davis - Department of Economics.
- Antoni Bosch-Domènech & Joaquim Silvestre, 1996. "Credit constraints in general equilibrium: Experimental results," Economics Working Papers 105, Department of Economics and Business, Universitat Pompeu Fabra.
- Joaquim Silvestre & Antoni Bosch-Domenech, 2004. "Credit Constraints In General Equilibrium: Experimental Results," Working Papers 957, University of California, Davis, Department of Economics.
- Gjerstad, S., 2006.
"The Competitive Market Paradox,"
Purdue University Economics Working Papers
1180, Purdue University, Department of Economics.
- Markose, Sheri & Arifovic, Jasmina & Sunder, Shyam, 2007. "Advances in experimental and agent-based modelling: Asset markets, economic networks, computational mechanism design and evolutionary game dynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 31(6), pages 1801-1807, June.
- Tesfatsion, Leigh S., 2002. "Agent-Based Computational Economics: Growing Economies from the Bottom Up," Staff General Research Papers Archive 5075, Iowa State University, Department of Economics.
- Easley, David & Ledyard, John., "undated". "Theories of Price Formation and Exchange in Double Oral Auctions," Working Papers 611, California Institute of Technology, Division of the Humanities and Social Sciences.
When requesting a correction, please mention this item's handle: RePEc:pur:prukra:1204. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Krannert PHD)
If references are entirely missing, you can add them using this form.