TY  - JOUR
AU  - Biais,Bruno
AU  - Hombert,Johan
AU  - Weill,Pierre-Olivier
TI  - Trading and Liquidity with Limited Cognition
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 16628
PY  - 2010
Y2  - December 2010
UR  - http://www.nber.org/papers/w16628
L1  - http://www.nber.org/papers/w16628.pdf
N1  - Author contact info:
Bruno Biais
Toulouse School of Economics (CNRS, IDEI)
Manufacture des Tabacs
21, allée de Brienne
31000 TOULOUSE
FRANCE
Tel: fax 33/0561-128637
E-Mail: bruno.biais@univ-tlse1.fr

Johan Hombert
HEC Paris
1 rue de la Liberation
78351 Jouy en Josas
France
E-Mail: hombert@hec.fr

Pierre-Olivier Weill
Department of Economics
University of California, Los Angeles
Bunche Hall 8283
Los Angeles, CA 90095
Tel: 310/794-6495
Fax: 310/825-9528
E-Mail: poweill@econ.ucla.edu
AB  - 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.
ER  -