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Open Access Publications from the University of California

Private Information, Prices, and Market Efficiency


In our economy the most important prices--longterm interest rates, for example--are the aggregate result of many self-interested individuals strategically making trades based on their privately perceived costs, values, and expectations. If these prices are to guide individuals into making efficient decisions, then each must be the competitive price that successfully clears its market and correctly impounds traders' private information. Economists have long believed that markets do this well, but have been unclear as to how a market in fact extracts sufficient information from its participants in order to arrive at a close approximation to the competitive price. Insight into this question may be obtained through understanding the incentives that the double auction gives participants to reveal their information. A double auction is a stylized market institution that explicitly recognizes that buyers and sellers' possess essential private information. In equilibrium the double auction demonstrates a remarkable ability to extract information from traders, arrive at the competitive price, and make an optimal allocation

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