Over-the-counter versus double auction in asset markets with near-zero-intelligence traders

Over-the-counter (OTC) markets dominate trading in many asset classes. We examine the role of OTC trading institutions on price discovery and bubble formation by constructing an agent-based model with artificial adaptive traders placed in a laboratory market environment. We compare (i) OTC markets without dealers; (ii) OTC markets with dealers; and (iii) standard double auction (DA) markets. Under the same parameters estimated from the DA experimental data, we find that replacing DA with OTC trading institutions does not mitigate price bubbles. After recalibrating the model using the OTC experimental data, we find that anchoring effects are lower and selling pressures are higher in OTC markets than DA markets. The simulated results show smaller price bubbles in OTC markets than in DA markets, which is consistent with the experimental data. This result highlights the important role played by the interaction between trading institutions and the agent’s behavioral biases in bubble formation.