An `Inverse' Experimental Framework to Estimate Market Efficiency

TL;DR

This paper introduces an inverse experimental framework that predicts market efficiency metrics from orderbook data alone, enabling early assessment of market performance without relying on true valuation data.

Contribution

It proposes a novel inverse modeling approach using quantile normalization and machine learning to estimate market efficiency from unstructured orderbook data.

Findings

Models predict allocative efficiency reasonably well from early bids and asks.

Prediction accuracy improves with additional price data.

Framework applicable to real-world market data for early efficiency assessment.

Abstract

Digital marketplaces processing billions of dollars annually represent critical infrastructure in sociotechnical ecosystems, yet their performance optimization lacks principled measurement frameworks that can inform algorithmic governance decisions regarding market efficiency and fairness from complex market data. By looking at orderbook data from double auction markets alone, because bids and asks do not represent true maximum willingnesses to buy and true minimum willingnesses to sell, there is little an economist can say about the market's actual performance in terms of allocative efficiency. We turn to experimental data to address this issue, `inverting' the standard induced value approach of double auction experiments. Our aim is to predict key market features relevant to market efficiency, particularly allocative efficiency, using orderbook data only -- specifically bids, asks and price realizations, but not the induced reservation values -- as early as possible. Since there is no established model of strategically optimal behavior in these markets, and because orderbook data is highly unstructured, non-stationary and non-linear, we propose quantile-based normalization techniques that help us build general predictive models. We develop and train several models, including linear regressions and gradient boosting trees, leveraging quantile-based input from the underlying supply-demand model. Our models can predict allocative efficiency with reasonable accuracy from the earliest bids and asks, and these predictions improve with additional realized price data. The performance of the prediction techniques varies by target and market type. Our framework holds significant potential for application to real-world market data, offering valuable insights into market efficiency and performance, even prior to any trade realizations.