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Modelling Price Pressure in Financial Markets
Elena Asparouhova‡ and Peter Bossaerts§
This version: March 2008
‡University of Utah, e.asparouhova@
§EPFL Lausanne and CEPR, peter.bossaerts@epfl.ch
We thank participants in seminars at Caltech, the Indiana University, the University of Utah, the EFA and EFMA
2004 Meetings. Financial support from the R.J. Jenkins Family Foundation, the National Science Foundation (grant SES-
0079374), and the William D. Hacker Chair at Caltech are gratefully acknowledged. Ultimately only the authors are
responsible for remaining errors, however.
1
Modeling Price Pressure in Financial Markets
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 aspi-
ration levels. Marginal valuations, order prices, and hence, transaction prices change correspondingly.
The resulting price adjustment process coincides with the Global Newton Method. The assumptions
of the model as well its empirical implications are fully borne out by the data. Our model thus
provides economic foundation for why markets appear to search for equilibrium according
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