Collaborative Research: The Evolution of Prices and Allocations in Markets: Theory and Experiment

University Of California-Los Angeles, Los Angeles CA

Investigators

Abstract

Prop ID: 0317715 P I: Plott, Charles R. Organization: California Institute of Technology Title: Collaborative Research: The Evolution of Prices and Allocations in Markets: Theory and Experiment CO-PI: Peter Bossaerts/Cal Tech; William Zame/UCLA (Collaborative) The goal of the proposed research is to understand the dynamics of prices and choices in multi-security/multi-good markets. Do markets get to equilibrium, and how? This research concentrates on a simple environment: trade takes place during some period of time, but information is revealed and consumption takes place only at the end of the period. Within this context, the investigators study price and allocation dynamics experimentally and discover a number of regularities in the data: (i) prices eventually settle close to the theoretical equilibrium; (ii) price changes for a particular good are correlated with excess demand of all goods; (iii) trades are small. Motivated by these empirical findings, the investigators propose a local adjustment model, in the spirit of local models suggested by Smale, to explain these phenomena. The purpose of this project is to study the theoretical properties of the model and to link it to data through a series of experiments. Because agents in the model make adjustments that are only locally optimal, the model is in the spirit of much work on limited rationality. However, the end process of the adjustment process is quite rational, and the adjustment process is more robust than most models in the literature. Thus the model illustrates how markets can be smart even though they are populated by human beings of limited capacity. The proposed research is meant to provide a more solid empirical foundation for our theoretical understanding of the evolution of prices and choices in competitive markets for several goods/securities. At the core of the research is a dialogue between theory and data, with econometrics providing the link. Broader Impacts: The issues studied here are critical for the many important existing markets in which several goods (including services and risky assets) are traded at the same time and in which the supply, demand and price of each of these goods depends in a complicated way on the supply, demand and price of other goods. The proposed work should lead to a better understanding of such interdependencies and therefore to a better understanding of the management of risks in such markets. The experiments proposed here depend on a web-based experimental technology (using unique facilities to which the research team has access) that permits the interaction of many participants in real time. Although technical challenges will continue to arise, there is no doubt that this experimental technology can be adapted to meet them. In addition to its usefulness as a research tool, this experimental technology will be useful as a teaching tool, and for providing broad based demonstrations of the science.