Paracrine function is a major mechanism of cell-cell communication within tissue microenvironment in normal development and disease. In vitro cell culture models simulating tissue or tumor microenvironment are necessary tools to delineate epithelial-stromal interactions including paracrine function, yet an ideal three-dimensional (3D) tumor model specifically studying paracrine function is currently lacking. In order to fill this void we developed a novel 3D co-culture model in double-layered alginate hydrogel microspheres, incorporating prostate cancer epithelial and stromal cells in separate compartments of the microspheres. The cells remained confined and viable within their respective spheres for over 30 days. As a proof of principle regarding paracrine function of the model, we measured shedded component of E-cadherin (sE-cad) in the conditioned media, a major membrane bound cell adhesive molecule that is highly dysregulated in cancers including prostate cancer. In addition to demonstrating that sE-cad can be reliably quantified in the conditioned media, the time course experiments also demonstrated that the amount of sE-cad is influenced by epithelial-stromal interaction. In conclusion, the study establishes a novel 3D in vitro co-culture model that can be used to study cell-cell paracrine interaction.