Two price economic equilibria and financial market bid/ask prices

Robert J. Elliott; Dilip B. Madan; Tak Kuen Siu

doi:10.1007/s10436-020-00377-x

Two price economic equilibria and financial market bid/ask prices

Robert J. Elliott, Dilip B. Madan^*, Tak Kuen Siu

^*Corresponding author for this work

Department of Actuarial Studies and Business Analytics

Research output: Contribution to journal › Article › peer-review

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.

Original language	English
Pages (from-to)	27-43
Number of pages	17
Journal	Annals of Finance
Volume	17
Issue number	1
Early online date	9 Nov 2020
DOIs	https://doi.org/10.1007/s10436-020-00377-x
Publication status	Published - Mar 2021

Keywords

Acceptable risks
Convex risk measures
Distorted expectations
Minmaxvar distortion

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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.",

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AU - Siu, Tak Kuen

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AB - 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.

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KW - Minmaxvar distortion

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Two price economic equilibria and financial market bid/ask prices

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Keywords

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