Price Discovery Using a Double Auction, Sept. 17.

We devise a model to study the buyer's bid double auction (BBDA) in small markets that is rich enough to allow correlated signals and interdependent values/costs but simple enough to permit analysis. We demonstrate that simple equilibria can exist even in small markets. Moreover, we bound strategic behavior as a function of market size and derive rates of convergence to zero of (i) the inefficiency in the allocation, and (ii) the error in the market price as an estimate of the rational expectations price, each as caused by the strategic behavior. These rates together with numerical examples suggest that strategic behavior can be inconsequential even in small markets in its effect on allocational efficiency and information aggregation. The BBDA can thus simultaneously accomplish both the informational and allocational goals that markets ideally fulfill; it does this perfectly in large markets and approximately in small markets, with the error attributable mainly to the smallness itself and not the strategic behavior that smallness engenders.