Convergence to Efficiency in a Simple Market with Incomplete Information

Aldo Rustichini

No 995, Discussion Papers from Northwestern University, Center for Mathematical Studies in Economics and Management Science

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.

Date: 1992-05
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Journal Article: Convergence to Efficiency in a Simple Market with Incomplete Information (1994)
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