QUOTES, PRICES, AND ESTIMATES IN A LABORATORY MARKET

This study examines the behavior of laboratory markets in which two un informed market makers compete to trade with heterogeneously informed investors. The data provide three main results. First, market makers s et quotes to protect against adverse selection and to control inventor y. Second, when investors are less well-informed, their trades are les s reliable measures of their information, and market makers respond to those trades with greater skepticism. Third, errors in market makers' reactions to trades cause the time-series behavior of quotes and pric es to depend on the information environment in ways beyond those captu red in extant theory.