Bias in price signals from ask only markets

Yesterday I listened to this superb podcast where Russ Roberts of the Hoover Institution interviews Josh Luber who runs Campless, a secondary market for sneakers (listen to the podcast, it isn’t as bizarre as it sounds). The podcast is full of insights on markets and “thickness” and liquidity and signalling and secondary markets and so on.

To me, one of the most interesting takeaways of the podcast was the concept that the price information in “ask only markets” is positively biased. Let me explain.

A financial market is symmetric in that it has both bids (offers to buy stock) and asks (offers to sell). When there is a seller who is willing to sell the stock at a bid amount, he gets matched to the corresponding bid and the two trade. Similarly, if a buyer is willing to buy at ask, the ask gets “taken out”.

The “order book” at any time thus contains of both bids and asks – which have been unmatched thus far, and looking at the order book gives you an idea of what the “fair price” for the stock is.

However, not all markets are symmetric this way. In fact, most markets are asymmetric in that they only contain asks – offers to sell. Think of your neighbourhood shop – the shopkeeper is set up to only sell goods, at a price he determines (his “ask”). When a buyer comes along who is willing to pay the ask price of a good, a transaction happens and the good disappears.

Most online auction markets (such as eBay or OLX) also function the same way – they are ask only. People post on these platforms only when they have something to sell, accompanied by the ask price. Once a buyer who is willing to pay that price is found, the item disappears and the transaction is concluded.

What makes things complicated with platforms such as OLX or eBay (or Josh Luber’s Campless) is that most sellers are “retail”, who don’t have a clear idea of what price to ask for their wares. And this introduces an interesting bias.

Low (and more reasonable) asks are much more likely to find a match than higher asks. Thus, the former remain in the market for much shorter amount of time than the latter.

So if you were to poll the market at periodic intervals looking at the “best price” for a particular product, you are likely to end up with an overestimate because the unreasonable asks (which don’t get taken out that easily) are much more likely to occur in your sample than more reasonable asks. This problem can get compounded by prospective sellers who decide their ask by polling the market at regular intervals for the “best price” and use that as a benchmark.

Absolutely fascinating stuff that you don’t normally think about. Go ahead and listen to the full podcast!

PS: Wondering how it would be if OLX/eBay were to be symmetric markets, where bids can also be placed. Like “I want a Samsun 26 inch flatscreen LCD TV for Rs. 10000”. There is a marketplace for B&Bs (not Airbnb) which functions this way. Would be interesting to study for sure!