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This paper describes the implementation of a one- hour classroom trading simulation originally
Overview
developed by the author when he was a trader at the Chicago Board of Trade. Pre-requisite
The experiment involves putting students into teams of 4 or 5 which function
student knowledge consists of market efficiency concepts, and the market-making process. The
as market-makers in a asset market. The students have partial knowledge
simulation involves putting students into teams of 4 or 5 (7 or 8 teams maximum) which function
of certain characteristics of this asset, but not full information. The experiemnt begins when eachteam posts a bid and ask price for the asset which is displayed for all market participants.
as OTC dealers/market-makers in a novel asset market. The students have intimate knowledge
of certain characteristics of this asset, but not full information. The simulation begins when each
team posts a bid and ask price for the asset which is displayed for all market participants.
Trading commences as each team is allowed to make one and only one trade with a competing
Trading commences as each team is allowed to make one and only one trade with a competing
market maker. Trades as well as bid/ask spreads are posted by the moderator who also interjects
market maker. Trades as well as bid/ask spreads are posted by the moderators who also vary infromation based on how the market adjusts. After each round of
with commentary tailored to the knowledge level of the students (active versus passive trading,
trading, the teams are allowed to revise their bid/ask spreads. The market makers should find that the effective bid/ask spread in the market narrows and eventually reaches equilibrium based purely as a function of trading since no new information is provided. Depending on the class and students, variations can be introduced including informed outside traders or economic releases. These variations may greatly alter the market at first, as overreaction could occur. The experiment concludes when the bid/ask spreads have effectively bracketed the “true value” of the asset known only to those conducting the experiment.
market maker risk, long and short concepts, price discovery concepts). After each round of
 
trading, the teams are allowed to revise their bid/ask spreads. Inevitably, students find that the
Questions to Look At:
effective bid/ask spread in the market narrows purely as a function of trading since no new
Before any new information entered the market, did the market effectively move?
information is provided. Depending on the class and students, variations can be introduced
What happens as new information arrives in the market?
including informed outside traders (“Mr. Arbitrage”), economic releases and comments by the
Was passive or active trading more affective?
Federal Reserve Chairman (suitably vague, of course). These variations allow the students to see
 
first hand the impact of new information on the market as bid/ask spreads widen, volatility
Emperical Evidence of Similar Experience:
increases “over-reaction” to information invariably occurs. The simulation concludes when the
bid/ask spreads have effectively bracketed the “true value” of the asset known only to the
instructor. The instructor concludes with a discussion of what it means for the market to
“process information” as demonstrated in the simulation while also reinforcing the concepts of
market-making, risk, market behavior and trading.

Revision as of 02:44, 11 April 2006

Overview 

The experiment involves putting students into teams of 4 or 5 which function

as market-makers in a asset market. The students have partial knowledge of certain characteristics of this asset, but not full information. The experiemnt begins when eachteam posts a bid and ask price for the asset which is displayed for all market participants. Trading commences as each team is allowed to make one and only one trade with a competing market maker. Trades as well as bid/ask spreads are posted by the moderators who also vary infromation based on how the market adjusts. After each round of trading, the teams are allowed to revise their bid/ask spreads. The market makers should find that the effective bid/ask spread in the market narrows and eventually reaches equilibrium based purely as a function of trading since no new information is provided. Depending on the class and students, variations can be introduced including informed outside traders or economic releases. These variations may greatly alter the market at first, as overreaction could occur. The experiment concludes when the bid/ask spreads have effectively bracketed the “true value” of the asset known only to those conducting the experiment.

Questions to Look At: Before any new information entered the market, did the market effectively move? What happens as new information arrives in the market? Was passive or active trading more affective?

Emperical Evidence of Similar Experience:

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