Efficient allocations in double auction markets

Abstract

This paper proposes a simple descriptive model of discrete-time double auction markets for divisible assets. As in the classical models of exchange economies, we consider a finite set of agents described by their initial endowments and preferences. Instead of the classical Walrasian-type market models, however, we assume that all trades take place in a centralized double auction where the agents communicate through sealed limit orders for buying and selling. We find that, under nonstrategic bidding, the double auction clears with zero trades precisely when the agents' current holdings are on the Pareto frontier. More interestingly, the double auctions implement Adam Smith's "invisible hand" in the sense that, when starting from disequilibrium, repeated double auctions lead to a sequence of allocations that converges to individually rational Pareto allocations.