Price Formation in Multiple, Simultaneous Continuous Double Auctions, with Implications for Asset Pricing

Abstract

We propose a Marshallian model for price and allocation adjustments in parallel continuous double auctions. Agents quote prices that they expect will maximize local utility improvements. The process generates Pareto optimal allocations in the limit. In experiments designed to induce CAPM equilibrium, price and allocation dynamics are in line with the model's predictions. Walrasian aggregate excess demands do not provide additional predictive power. We identify, theoretically and empirically, a portfolio that is closer to mean-variance optimal throughout equilibration. This portfolio can serve as a benchmark for asset returns even if markets are not in equilibrium, unlike the market portfolio, which only works at equilibrium. The theory also has implications for momentum, volume and liquidity.

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