Modern information systems technology has already had considerable impact on the operation of financial markets, but the most fundamental changes are yet to come. It is only in the last year or so that modern technology has begun to transform the core trading functions in major financial markets. In 1987, the London Exchange replaced its traditional specialists by a computer-aided trading mechanism. Most observers believe that the New York Stock Exchange and others, will make similar changes in the next few years. Yet there is too little solid understanding of electronic trading mechanisms to guide the fundamental changes that are now beginning to take place. This research contributes to our understanding of these mechanisms by investigating, through laboratory experiments, a number of the fundamental problems inherent in these electronic markets. Specifically, the researchers set up computerized laboratory markets employing three principal mechanisms: the continuous Double Auction (as presently used in the Chicago Mercantile Exchange); the Specialist Dealer System (as used in the New York Stock Exchange); and, the Call market (used to open many financial markets). The researchers test for systematic effects of the market mechanism on important market performance measures such as price errors, price volatility, allocational efficiency, the bid-ask spread and trader profits. Such evidence should help inform important policy decisions regarding the adoption of new information technologies in financial markets, and may also inspire new theoretical and empirical advances.
