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Walrasian Auctions, from Jim Sogi

December 19, 2007 |

 A Walrasian Auction is a market model in which a price is called and the participants decide if they are net sellers or net buyers. The price is adjusted until the net intended buying and selling are equal. Then the trades are made. It is a market clearing mechanism. The old Paris Bourse worked like this. Gold is set like this in London. What I propose is to approach the market from a reverse Walrasian viewpoint. In our markets, prices are theoretically continuous. At each price level, net selling and buying change and differ. This is one way price is changed. If one had a net long position which would be adjusted at various price levels, one could count or infer the net selling and buying, and take a contrarian position. The contrarian premise is that the selling panics are wrong and when net selling occurs, be a net buyer and vice versa. This strategy targets area of disequilibrium and walks hand in hand with cane investing. When there is disequilibrium, price moves large amounts as well.

Stefan Jovanovich adds:

If you own an operating business, you are always a net seller in the marketplace of the goods and/or services your company offers. One of the attractions of hedging for non-financial businesses is that it seems to offer the promise of allowing the business to take the other side of the trade. The problem is that, in almost all cases, you the business person are going from a position of at least reasonable knowledge to one where you are more than likely the sucker at the table. The panic right now among California small business people is that we can't even find a game to sit in on. This spring I wrote about how much confidence the local electricians and plumbers I know had about the remodeling market. Those same guys now are so discouraged that, even though they have plenty of time on their hands, they are not working on their own houses. They don't see any profit in spending any money on their own properties, and they wonder what will happen to them if homeowners generally come to the same conclusion.

Steve Ellison suggests: 

Larry WilliamsTrying to apply some of what I learned from the Senator's writings, I might look for Walrasian logic in the Commitments of Traders data. The commercials are buyers and sellers of last resort. If open interest increases while price moves primarily in one direction, the order flow is one-sided. If most speculators are rushing to buy, soon the only sellers left will be commercials. As commercials' hedges increase, the marginal utility of additional hedging decreases, and the commercials require better pricing to hedge more, much like dealers and market makers who have more inventory than they want.

As an example, consider the natural gas market. On October 30, the open interest was 742,551 contracts. Commercials were net long 21,792 contracts. The January contract price was 8.354. In the most recent report, as of December 11, the open interest was 829,008, and the January contract price was 7.085. Commercials were net long 74,850 contracts.

Comparing the two reports, open interest increased 86,457. One can infer from the commercials' increase in net longs of 53,058 that the majority of new contracts were initiated by speculators wanting to go short, with commercials taking the other side, as price decreased by 15%.


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