Trading in Networks: A Normal Form Game Experiment∗

This paper reports an experimental study of trading networks, in which exchange is intermediated by traders who form a chain of links between the initial seller of the asset and ultimate buyer of the asset. Traders choose bid and ask prices and trades are executed by the computer once subjects have submitted their strategies. Networks are incomplete in the sense that each trader can only exchange assets with a limited number of other traders. The greater the incompleteness of the network, the more intermediation is required to transfer the assets between initial and final owners. The uncertainty of trade in networks constitutes a potentially important market friction. As a result, the inferences subjects must draw in order to make optimal decisions are quite subtle. Nevertheless, we find that the pricing behavior observed in the laboratory converges to competitive equilibrium behavior in a variety of treatments. However, the rate of convergence varies depending on the network, pricing rule, and payoff function. Journal of Economic Literature Classification Numbers: C91, C92, G10, G19. ∗This research was supported by the Center for Experimental Social Sciences (C.E.S.S.) at New York University. We are grateful to Peter Bossaerts, Gary Charness, Syngjoo Choi, Thomas Palfrey, Charles Plott and William Zame for helpful discussions, and to three anonymous referees for their comments. The paper has also benefited from suggestions by the participants of seminars at several universities. Kariv is grateful to the hospitality of the Institute for Advances Studies School of Social Science. †Department of Economics, New York University, 19 West 4th Street, #808, New York, NY, 10012 (E-mail: [email protected], URL: http://www.econ.nyu.edu/user/galed). ‡Department of Economics, University of California, Berkeley, 505 Evans Hall # 3880, Berkeley, CA 94720 (E-mail: [email protected], URL: http://econ.berkeley.edu/~kariv/).