Two price economic equilibria and financial market bid/ask prices

Robert J. Elliott (), Dilip B. Madan () and Tak Kuen Siu
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Robert J. Elliott: University of South Australia
Dilip B. Madan: University of Maryland

Annals of Finance, 2021, vol. 17, issue 1, No 2, 27-43

Abstract: Abstract Demand and supply uncertainty lead to a model of markets that set prices to acceptable risk levels for excess supplies and net revenues. The result is a two price partial equilibrium economy. The equilibrium solutions are applied to two price financial market data to infer demand and supply elasticities and log normal volatilities from market quotes on bid and ask prices. Demand elasticities are observed to be higher than supply elasticities as are the volatilities. Normalizing observed volatilities to the volatility of the daily traded volume a market implied duration of the economic equilibrium is inferred. The median level of duration is around a minute and half with an interquartile range from 37 s to 2 min. For larger orders, bid and ask prices may be constructed by calibrating the demand and supply volatilities.

Keywords: Acceptable risks; Distorted expectations; Minmaxvar distortion; Convex risk measures (search for similar items in EconPapers)
JEL-codes: D53 D58 G10 (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1007/s10436-020-00377-x

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