Individual Rationality and Market Efficiency

Steven Gjerstad () and Jason Shachat

Purdue University Economics Working Papers from Purdue University, Department of Economics

Abstract: The demonstration by Smith [1962] 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 [1993]. 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.

Keywords: Bounded rationality; double auction; exchange economy; experimental economics; market experiment; "zero intelligence" model (search for similar items in EconPapers)
JEL-codes: C70 C92 D44 D51 (search for similar items in EconPapers)
Pages: 11 pages
Date: 2007-08
New Economics Papers: this item is included in nep-cbe, nep-cmp, nep-exp, nep-hpe and nep-knm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (16)

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Persistent link: https://EconPapers.repec.org/RePEc:pur:prukra:1204

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