Trading and liquidity with limited cognition

Johan Hombert, Bruno Biais and Pierre-Olivier Weill
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Johan Hombert: GREGH - Groupement de Recherche et d'Etudes en Gestion à HEC - HEC Paris - Ecole des Hautes Etudes Commerciales - CNRS - Centre National de la Recherche Scientifique

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Abstract: We study the reaction of financial markets to aggregate liquidity shocks when traders face cognition limits. While each financial institution recovers from the shock at a random time, the trader representing the institution observes this recovery with a delay, reecting the time it takes to collect and process information about positions, counterparties and risk exposure. Cognition limits lengthen the recovery process. They also imply that traders who find their institution has not yet recovered from the shock place market sell orders, and then progressively buy back at relatively low prices, while simultaneously placing limit orders to sell later when the price will have recovered. This generates round trip trades, which raise trading volume. We compare the case where algorithms enable traders to implement this strategy to that where traders can only place orders when they have completed their information processing task.

Keywords: liquidity; limited cognition; Trading (search for similar items in EconPapers)
Date: 2012-12-04
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Published in 2012

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Related works:
Working Paper: Trading and liquidity with limited cognition (2012)
Working Paper: Trading and Liquidity with Limited Cognition (2011)
Working Paper: Trading and Liquidity with Limited Cognition (2010)
Working Paper: Trading and Liquidity with Limited Cognition (2010)
Working Paper: Trading and Liquidity with Limited Cognition (2010)
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