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Trading and liquidity with limited cognition

Listed author(s):
  • 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)

  • Bruno Biais

    (CRM - Centre de Recherche en Management - UT1 - Université Toulouse 1 Capitole - CNRS - Centre National de la Recherche Scientifique)

  • Pierre-Olivier Weill

    (UCLA - University of California at Los Angeles [Los Angeles], NBER - The National Bureau of Economic research)

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.

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Paper provided by HAL in its series Working Papers with number hal-00760759.

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Date of creation: 04 Dec 2012
Publication status: Published in 2012
Handle: RePEc:hal:wpaper:hal-00760759
Note: View the original document on HAL open archive server: https://hal-hec.archives-ouvertes.fr/hal-00760759
Contact details of provider: Web page: https://hal.archives-ouvertes.fr/

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