This research explores the finding that thin experimental financial markets fail to fully equilibrate, evidently because volume dries up before equilibrium is reached. That is, equilibration apparently halts because of lack of liquidity. It has been conjectured that the trading mechanism is at fault. Specifically, a mechanism where agents are forced to trade in parallel, unconnected markets is thought to be a probable cause inhibiting portfolio rebalancing. The present paper investigates this conjecture, by organizing markets directly as a portfolio trading mechanism, allowing agents to better coordinate their orders across securities. We present graphical evidence that our portfolio trading mechanism, an implementation of the combined-value trading (CVT) system, facilitates full equilibration. Equilibration occurs before volume (liquidity) decreases, suggesting that the eventual decline in trading merely reflects that gains from trade are exhausted. We also reject formally that prices follow a (multi-dimensional) random walk, in favor of stochastic attraction towards the equilibrium predicted by CAPM and the Arrow-Debreu complete-markets equilibrium.

Co-author Peter Bossaerts and Leslie Fine