NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

NBER Publications by Johan Hombert

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December 2010Trading and Liquidity with Limited Cognition
with Bruno Biais, Pierre-Olivier Weill: w16628
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...

Contact and additional information for this authorAll papers and publicationsWorking Papers onlyWorking Papers with publication info

 
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