PRICE FORMATION IN DOUBLE AUCTIONS

We develop a model of information processing and strategy choice for p articipants in a double auction. Sellers in this model form beliefs th at an offer will be accepted by some buyer. Similarly, buyers form bel iefs that a bid will be accepted. These beliefs are formed on the basi s of observed market data, including frequencies of asks, bids, accept ed asks, and accepted bids. Then traders choose an action that maximiz es their own expected surplus. The trading activity resulting from the se beliefs and strategies is sufficient to achieve transaction prices at competitive equilibrium and complete market efficiency after severa l periods of trading. (C) 1998 Academic Press.