Price change autocorrelation
When traders base their reservation on market bid and ask prices, their beliefs about the
market price will change according to the new bids and asks in the market. This leads to
positive autocorrelated transaction price changes. According to Kagel (1996) and
Friedman (1984), the serial correlation in price change is enhanced when traders gain
experience.
4. Results
Allocative efficiency
Following Smith (1962) and Cason and Friedman (1996), allocative efficiency is defined
as total profits earned divided by the maximum total profit that could have been earned
by all the traders, or the sum of producer and consumer surplus. The surplus is
maximized when permits are allocated to highest value traders from lowest cost traders.
(Weitzman, 1974).
In the allocation market, as the government did not know the value of each trader, the
permits were given randomly to the drivers. This did not only allow high value traders to
own permit but also the low value traders. This misallocation was corrected in the auction
market when high value traders offered a price higher than the cost of the permit owner.
The reallocation of permit in the auction market works as follows. A trader will demand a
permit if the price is lower than his/her value. If the price offered by the trader is higher
than the cost of the permit owner, the owner of the permit is willing to sell the permit.
Efficiency is achieved when both buyer and seller earn positive surplus.
Figure 3 shows the difference in ownership of permits before and after the auction
market. In the first allocation stage, drivers in value categories 1 to 15 owned a total of 42
permits compared with 47 permits in categories 16 to 30. This is corrected after the
auction when the former category of traders owns only 26 permits and the latter owns 63
permits.