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Marketmaking in the Laboratory: Does Competition Matter?

Published online by Cambridge University Press:  14 March 2025

Jan Pieter Krahnen  and
Martin Weber
Jan Pieter Krahnen*
Affiliation:
Goethe Universitaet Frankfurt, Finance Department (Germany), CFS Center for Financial Studies, and CEPR
Martin Weber*
Affiliation:
Universitaet Mannheim, Lehrstuhl Bankbetiiebs Lehre (Germany)
*
email: krahnen@wiwi.uni-frankfurt.de
email: weber@bank.bwl.uni-mannheim.de
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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.

Keywords

market microstructuredealer marketbid-ask spreadcompetition

JEL classification

C91: Laboratory, Individual Behavior G14: Information and Market Efficiency • Event Studies • Insider Trading
Type
Research Article
Information
Experimental Economics , Volume 4 , Issue 1 , June 2001 , pp. 55 - 85
Copyright
Copyright © 2001 Economic Science Association

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Footnotes

*

Author to whom all correspondence should be addressed.

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