Mechanism Design in Dynamic Trading Environments

Project: Research

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Description

This project develops a new game theoretical framework for analyzing dynamic trading environments. This project primarily concerns situations in which an informed trader faces a sequence of uninformed traders who sequentially arrive and negotiate terms of trade. The key features of the framework are the following: (i) the gain from trading is the informed trader’s private information, (ii) the informed trader can freely switch from negotiating with one counterparty to another, and (iii) uninformed traders compete with each other by offering different sales mechanisms to attract the informed trader. Compared to existing frameworks in the literature, this framework affords a wider array of sales mechanisms to uninformed traders. The set of available mechanisms includes price-posting mechanisms, option contracts, and all standard bargaining protocols. This feature renders the framework applicable to various environments, including markets for retail products in which price-posting mechanisms are prevalent and financial markets in which more sophisticated mechanisms (e.g., option contracts) are commonplace. In terms of methodology, the project combines dynamic game theory and competing mechanism design approaches. The dynamic game theory approach assumes that the trading process follows a specific extensive-form game whose rule is chosen outside of the game. On the other hand, the competing mechanism design assumes that traders inside the market choose the trading process themselves. The combination of these two approaches is expected to provide a complete picture of how markets function in dynamic environments. The project applies the new framework to various theoretical and policy-related questions, such as:The project examines which mechanisms are chosen by uninformed traders in different environments. This research is expected to provide insights into why different mechanisms are observed in different markets.The project examines how changes in the information structure affect the equilibrium trading pattern. This research will answer the question as to how market transparency/opacity affects market outcomes. The same question has also been the focus of recent policies in, for example, insurance, credit, and financial markets. The project is expected to improve our understanding of these policies.The project investigates how changes in the arrival process of uninformed traders affect the equilibrium market outcome. In particular, it aims to investigate whether or not the equilibrium outcome approaches the competitive equilibrium outcome as the friction in the arrival process vanishes. This research is expected to provide a game theoretical foundation for competitive equilibrium theory. 

Detail(s)

Project number9042714
Grant typeGRF
StatusActive
Effective start/end date1/01/19 → …