The exposure problem and market design

Abstract

Markets have an exposure problem when getting to the optimal allocationrequires a sequence of transactions which if started but not completed leavesat least one trader with losses. We use laboratory experiments to evaluatethe effect of the exposure problem on alternative market mechanisms. Thecontinuous double auction performs poorly: efficiency is only 20% when expo-sure is high and 55% when it is low. A package market effectively eliminatesthe exposure problem: in low and high exposure treatments efficiency is 82%and 89% respectively. Building on stability notions from matching theory weintroduce the concept of mechanism stability. A model of trade that com-bines mechanism stability with noisy best responses and imperfect foresightexplains the difference in market performance. Finally, decentralized bargai-ning with contingent contracts performs well with perfect information andcommunication but not in the more realistic case when traders’ preferencesare privately known.