Unformatted text preview: Call Market Auction Versus the Posted Offer Market The Call Market Auction opens the New York Stock Exchange each dayvery efficient. In general, just as game theory predicts, call markets are highly efficient and reach theoretical equilibrium prices very quickly. But, the most common market is the Posted Offer Market where sellers post one price each for all units they sell and buyers can take it or leave it. This is just like the supermarket, gas stations, etc. Buyers search for the best price among sellers.
Lecture 10 AEM 414 Design of Call Auction and Posted Offer Market Experiments Each of n sellers has two units to sell. Demand is for up to 2n units for the first half of the experiment (dotted blue line) and up to n units in the second half (solid blue line). In the Call Market separate offers for each unit. In the Posted Offer Market only one price is posted. Equilibrium prices are $4.50 in the first half of the experiment and $2.50 in the second half. AEM 414 Lecture 10 Average prices from last years experiments: Posted Offer First
Call Market Predicted and Average Prices
$5.00 $4.50 $4.00 $3.50 $3.00 Price P redic ted Pric e A verage Pric e
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 $2.50 $2.00 $1.50 $1.00 $0.50 $- Round Po ste d Of f er Market Predicted and Ave rag e Price s
$5 .00 $4 .50 $4 .00 $3 .50 $3 .00 $2 .50 $2 .00 $1 .50 $1 .00 $0 .50 $0 1 2 3 4 5 6 7 8 9 Predic t ed Pric e Average Pric e Prices track equilibrium very well in the call market. Note that when demand falls the call market reaches instant equilibrium. Prices track somewhat less precisely in the posted offer market. When demand falls no price exists in the posted offer market because NO UNITS were sold for that round!!!
Lecture 10 Price Round AEM 414 Average prices from this year’s experiments: Call Market First Prices track equilibrium less well in the call market. Note that when demand falls the call market does not reach instant equilibrium. Prices track somewhat less precisely in the posted offer market. So knowing the demand shift really helps market performance in both markets but posted offer performs less well. AEM 414 Lecture 10 Last Year’s Efficiency= 100*(Money Made/Maximum Money to be Made)
Call Market Efficiency (# possible trades / # actual trades)
100% 90% 80% 70% Percent 60% 50% 40% 30% 20% 10% 0% 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Round Posted Offer Market Efficiency (# possible trades / # actual trades)
100% 90% 80% 70% Percent 60% 50% 40% 30% 20% 10% 0% 1 2 3 4 Round 5 6 7 8 What does this mean for sellers in a posted offer market (could be you)? If you do not know demand is falling (posted offer first), you will set prices and output too high and be shut out of the market. Consider falling demand for SUVs and the disaster that hit US automakers. Sales of SUVs collapsed. Sellers in posted offer markets must make accurate demand forecasts to price correctly. Note demand shift was a surprise in the Posted Offer. AEM 414 Lecture 10 This Year’s Efficiency (Demand Shift Not a Surprise in Posted Offer)= 100*(Money Made/Maximum Money to be Made) What does this mean for sellers in a posted offer market (could be you)? If you know demand is falling (posted call market first), you will set prices lower and cut production and not be shut out of the market. Sellers in posted offer markets who know demand is falling can price better. Note that if supply shifts that means that seller costs change and they are aware of this. So no problem with supply shifts. Call market still performs better. AEM 414 Lecture 10 Why anomalous posted offer disequilibrium markets explain Macroeconomics QuickTime™ and a TIFF (Uncompressed) decompressor are needed to see this picture. If demand shifts from D1 (with all sellers posting P1) to D2 sellers do not know how much to drop price if at all. Say they try P2, then instead of selling Qe, they only sell Qd, getting stuck with unsold units and lay off workersa recession begins. The labor market can behave the same way causing even worse unemployment. QuickTime™ and a TIFF (Uncompressed) decompressor are needed to see this picture. AEM 414 Lecture 10 Behavioral Accounting Failures in accounting are one of the most significant sources of business failure. You cannot produce a product unless you know how much it costs to produce it. Some examples:
Before restructuring, electric utilities had no idea how much it was costing to generate electricity on a plant by plant basis. Early in my career I was on the board of a solar energy company (Soltrax) that was run like a mini Enron. The entire board resigned (including Chairman Bill Gross who invented the tape deck) over accounting related issues, cost control, and stock price manipulation. External audits by accounting firms also play the role of guaranteeing the quality of financial information made available to stockholders and other investors. But, who guarantees the quality of auditors.
Lecture 10 AEM 414 Behavioral accounting looks at how decision anomalies can bias accounting decisions and auditors’ opinions. Accounting information is produced in a world that suffers from a famous anomaly called the “Lemons Problem.” Akerlof asked: “Why do the prices of year or month old cars drop so precipitously?” The answer is asymmetrical information in the market for used cars. The seller knows the true condition of the car and the buyer does not. So, buyers assume that a car sold just after purchase is a “lemon” and are only willing to pay very low prices. Efficient markets require perfect information. Obviously accounting firms are in the business of providing “perfect” information to markets. But, the quality of audits themselves is subject to the “lemons” problem!
Lecture 10 AEM 414 Lemons for Sale? For example, Arthur Andersen was a Lemon!!! Enron’s stockholders trusted that Arthur Andersen would not let “fake” reports of profits be disseminated. The formerly big five accounting firms used on Wall Street were there because of reputation. Sellers of used cars and audits can develop a reputation with buyers of delivering a quality product that can solve the “lemons” problem. Once Arthur Andersen’s reputation was shot, they were effectively out of business. Where did all the investment banking firms go? Reputation???
Lecture 10 AEM 414 To examine this situation, let’s look at a lemons experiment run by Lynch et al (1986). Supers are worth more to buyers and cost more to make for sellers than regulars. The consumer surplus for each unit (difference between value and cost) if sellers choose to produce supers as opposed to regulars (which cost less to make but are worth much less to buyers) is substantially greater, so an efficient market should only produce supers. QuickTime™ and a TIFF (Uncompressed) decompressor are needed to see this picture. AEM 414 Lecture 10 Results QuickTime ™ and a TIFF (Uncompressed) decompressor are needed to see this picture. QuickTime ™ and a TIFF (Uncompressed) decompressor are needed to see this picture. If quality claims are prohibited for sellers, the market only produces regulars. If truthful claims are allowed for sellers, then only supers are produced. If sellers identities are known, then the market produces supers (reputation). AEM 414 Lecture 10 Your Setup
Demand V.s Supply - 1 pm section 8 7 6 5
Price 4 3 2 1 0 0 5 10 15 20 25 30
Quatity Dr Ss Sr Ss 35 40 45 50 55 60 AEM 414 Lecture 10 Your Results:
Lemon Experiment - 9am
7 6 5 Price 3 2 1 0 0 1 2 3 4 Round 5 6 7 8 9 4 Lemon Experiment - 12pm section
8 7 6
Regular Super Price 5 4 3 2 1 0 0 1 2 3 4 Round 5 6 7 8 9 Regular Super Lemon Experiment - 12pm section
8 7 6 Price 5 4 3 2 1 0 0 1 2 3 4 Round 5 6 7 8 9 Regular Super AEM 414 Lecture 10 Application to Insider Trading The same type of analysis also applies to insider trading. If insiders (e.g., some of the people in a bubble experiment) know what the dividend draw will be prior to an asset market round, the market price ends up (in the double auction where bids and offers are public) to be much closer to the full information situation than to the insider private information situation. So, information can leak if bids and offers are public information as in the NYSE! Behavioral accounting studies all aspects of accounting information.
Lecture 10 AEM 414 Auditors Must Use Judgment Lots of psychology experiments have been run to test for bias in judgments by auditors. Many of the biases we discussed associated with the hot hand, regression to the mean, self serving bias, status quo bias, loss aversion and risk seeking behavior, etc., hold true for auditors (or MBAs). For example, think of yourself as a young Arthur Andersen auditor going on your first trip to that “hot” company, ENRON (before all the trouble). Would you have been tempted to not follow up on suspicions about a client that: 1) Had a hot hand (unaware of regression to the mean), 2) Had passed all previous audits with flying colors (making too much of too little), and 3) Did a large consulting business with Arthur Andersen (self serving bias)?
Lecture 10 AEM 414 ...
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- Fall '08
- Financial Markets, Efficient-market hypothesis, Arthur Andersen, Enron scandal, Offer Market