Copyright © 1996, Agorics, Inc.

The Double Auction

-by Kate Reynolds

One in a Series of Articles from Agorics, Inc.

Although not classified as one of the major four auction types, the double auction has been the principal trading format in U.S. financial institutions for over a hundred years.

In this auction both sellers and buyers submit bids which are then ranked highest to lowest to generate demand and supply profiles. From the profiles, the maximum quantity exchanged can be determined by matching selling offers (starting with lowest price and moving up) with demand bids (starting with highest price and moving down). This format allows buyers to make offers and sellers to accept those offers at any particular moment. It can be confusing to think about the double auction in light of overlapping buy and sell orders. A good way to avoid this confusion is to understand that at one single instant of time, they do not overlap.

It works like this: Suppose 4 sellers of foreign exchange offer to sell one unit at prices of 100, 200, 300, and 400 units of domestic currency, and 4 demanders of foreign exchange offer to buy one unit at prices of 400, 300, 250, and 50 units of domestic currency. Supply and demand are met at three units of foreign exchange but the price would remain indeterminate, falling somewhere between 200 and 250. [Feldman]

The origins of the double auction are not well known, but it is recognized that this form of auction has roots that go back to ancient Egypt and Mesopotamia. Almost certainly the double auction stems from "haggling" in which buyer and seller each suggest prices. [Friedman, Daniel]

Much later (in the last quarter of the nineteenth century) when the telegraph and telephone were invented, traders in the stock market could speak directly to interested outside investors. This was viewed at the time not only as a novelty but also as something of a threat. The computer revolution of the twentieth and twenty-first centuries portend far greater shifts as agents and financial markets become automated. [Friedman, Daniel]

A "continuous double auction" is one in which many individual transactions are carried on at a single moment and trading does not stop as each auction is concluded. The pit of the Chicago Commodities market is an example of a continuous double auction and the New York Stock Exchange is another. In those institutions a specialist matches bids and asking prices to find matches.

One interesting variation is the Double Dutch auction. Work on this is being done at the University of Arizona. [McCabe]

It works like this: A buyer price clock starts ticking at a very high price and continues downward. At some point the buyer stops the clock and bids on the unit at a price favorable to him. At this point a seller clock starts upward from a very low price and continues to ascend until stopped by a seller who then offers a unit at that price. Then the buyer clock resumes in a downward direction. The trading period is over when the two prices cross, and at that point all purchases are made at the crossover point.

The DA (double auction) has many variants and is evolving rapidly. Economists believe that the double auction will have many applications as auctions become computerized.

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