Experimental Economics
Fall 2009
Yale University

How does bankruptcy protection affect a
double auction securities market?
 Examining price, leverage, number of
transactions, and market efficiency
We began exploring the concepts of debt and
borrowing in economies
 Leverage in financial markets has been called
one of the main factors contributing to the
recent financial crisis
 Most of the large participants in securities
markets use leverage (hedge funds, investment
banks, trading shops)
 We wanted to explore how different downside
risk scenarios affect leverage in the market as
well as the price and efficiency of the market
itself



We predicted that the presence of
bankruptcy protection would incentivize
buyers in the market to borrow more and the
market would reach an equilibrium price
higher than that of the market without
bankruptcy protection
Without bankruptcy protection, we expected
market participants to behave more
conservatively and risk conscious


Double auction securities market
Designated buyers and sellers
 14 Buyers endowed with 0 assets and 150 cash
 7 Sellers endowed with 6 assets and 0 cash



Two periods of trading in each round
Participant could borrow up to 3x initial cash
balance
Coin toss at end of each period to determine
high or low security payout
 Seller payout was 150 high / 100 low
 Buyer payout was 300 high / 100 low
Round 1: Period 1
Round 1: Period 2
240
240
220
220
200
200
180
160
Price
Price
180
Ask
Bid
Transaction
Ask
Bid
Transaction
160
140
140
120
120
100
100
0
5
10
15
20
25
30
35
40
45
50
0
5
10
15
Transaction Number
20
25
30
35
40
Transaction Number
Round 2: Period 1
Round 2: Period 2
240
240
220
220
200
200
Ask
Bid
Transaction
160
Price
180
Price
180
140
140
120
120
100
Ask
Bid
Transaction
160
100
0
5
10
15
20
25
30
Transaction Number
35
40
45
50
0
5
10
15
20
25
Transaction Number
30
35
40
45
Round 4: Period 1
Round 3: Period 2
240
240
220
220
200
200
180
160
Price
Price
180
Bid
Ask
Transaction
Ask
Bid
Transaction
160
140
140
120
120
100
100
0
5
10
15
20
25
30
0
5
10
15
Transaction Number
20
25
30
35
Transaction Number
Round 4: Period 2
Round 3: Period 1
240
240
220
220
200
200
180
Ask
Bid
Transaction
160
Price
Price
180
Ask
Bid
Transaction
160
140
140
120
120
100
100
0
5
10
15
20
Transaction Number
25
30
35
0
5
10
15
20
25
Transaction Number
30
35
40
Transaction Volume
Trading Volume
35
30
25
Number of Transactions

20
15
10
5
0
0
1
2
3
4
5
Period Number
6
7
8
9
Market Efficiency
Market Efficiency
80%
70%
60%
50%
Efficiency

40%
30%
20%
10%
0%
0
1
2
3
4
5
Period Number
6
7
8
9
Leverage
Average Buyer Leverage
1.6
1.4
1.2
Leverage Ratio

1.0
0.8
0.6
0.4
0.2
0.0
0
1
2
3
4
5
Period Number
6
7
8
9
Asset Price: We expected a price between 125 and
200. No noticeable bankruptcy specific pattern.
Perhaps our mistake in keeping prices constant.
 Market Efficiency: In the rounds with bankruptcy
protection, the market was more efficient by
approximately 10-15%
 Number of Transactions: There were significantly
more transactions in rounds with bankruptcy
protection
 Leverage: In the rounds with bankruptcy protection
average leverage was 1.1 and 0.7, and in rounds
without average leverage was 0.7 and 0.4


While leverage is often criticized and blamed
for instability in securities markets, there
seem to be advantages in market efficiency
and overall transaction volume



Is there a link between asset prices and
leverage ratios in the market?
Should the government regulate individual’s
leverage ratios?
Is there a more efficient structuring for
bankruptcy protection?