Experimental Economics

, Volume 4, Issue 1, pp 55–85

Marketmaking in the Laboratory: Does Competition Matter?

Authors

  • Jan Pieter Krahnen
    • Finance DepartmentGoethe Universitaet Frankfurt
    • CFS Center for Financial StudiesCEPR
  • Martin Weber
    • Lehrstúhl Bankbetiiebs LehreUniversitaet Mannheim
Article

DOI: 10.1023/A:1011493421952

Cite this article as:
Krahnen, J.P. & Weber, M. Experimental Economics (2001) 4: 55. doi:10.1023/A:1011493421952

Abstract

This paper is the first experimental study of the effects of competition and adverse selection on the performance of market maker (MM-) markets. Information distribution may is either symmetric or heterogeneous. MM-markets are either monopolistic (the specialist markets), or competitive (the multi MM-market). Welfare comparisons are with respect to a continuous double auction (DA-) market. Informed subjects receive an imperfect signal of the true state of the world. We find three main results. First, competition among market makers significantly reduces the bid-ask spread, and increases transaction volume. Second, competition among market makers induces competitive undercutting, yielding net trading losses for market makers as a group in most periods. Third, from the perspective of uninformed traders, a competing MM-regime is optimal, since it minimizes their expected trading losses.

market microstructuredealer marketbid-ask spreadcompetition

Copyright information

© Kluwer Academic Publishers 2001