Trading and Liquidity with Limited Cognition

Bruno Biais, Johan Hombert and Pierre-Olivier Weill

No 16628, NBER Working Papers from National Bureau of Economic Research, Inc

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 reflecting the time it takes to collect and process information about positions, counterparties and risk exposure. Cognition limits lengthen the market price recovery. They also imply that traders who find that 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 place orders only when they have completed their information processing task.

JEL-codes: D83 G12 (search for similar items in EconPapers)
Date: 2010-12
Note: AP
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Published as "Equilibrium Pricing and Volume under Preference Uncertainty" with Bruno Biais and Johan Hombert. Review of Economic Studies, Volume 81, Issue 4, Pp. 1401-1437.

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Related works:
Working Paper: Trading and liquidity with limited cognition (2012)
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)
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