Modelling Price Pressure in Financial Markets

26 Pages Posted: 3 Jun 2004

See all articles by Peter Bossaerts

Peter Bossaerts

University of Melbourne - Department of Finance; University of Cambridge

Elena N. Asparouhova

University of Utah - David Eccles School of Business

Date Written: August 2003

Abstract

We present experimental evidence that security prices do not respond to pressure from their own excess demand, unlike traditionally assumed in economic theory. Instead, prices respond to excess demand of all securities, despite the absence of a direct link between markets. We propose a model of price pressure that explains these findings. In our model, agents set order prices that reflect the marginal valuation of desired future holdings, called aspiration levels.

In the short run, as agents encounter difficulties executing their orders, they scale back their aspiration levels. Marginal valuations, order prices, and hence, transaction prices change correspondingly.

Our model makes a specific prediction about the nature of cross-security effects: the covariance between a security's transaction price and another security's excess demand will be proportional to the corresponding covariance. This additional prediction is fully borne out by the data.

Suggested Citation

Bossaerts, Peter L. and Asparouhova, Elena N., Modelling Price Pressure in Financial Markets (August 2003). Available at SSRN: https://ssrn.com/abstract=492923 or http://dx.doi.org/10.2139/ssrn.492923

Peter L. Bossaerts

University of Melbourne - Department of Finance ( email )

Faculty of Economics and Commerce
Department of Finance
Carlton, Victoria 3010
Australia

HOME PAGE: http://bmmlab.org

University of Cambridge ( email )

Trinity Ln
Cambridge, CB2 1TN
United Kingdom

Elena N. Asparouhova (Contact Author)

University of Utah - David Eccles School of Business ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States

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