Trading and Liquidity with Limited Cognition

Biais, Bruno, Hombert, Johan and Weill, Pierre-Olivier (2010) Trading and Liquidity with Limited Cognition. TSE Working Paper, n. 10-242, Toulouse

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Official URL: http://tse-fr.eu/pub/24591

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.

Item Type: Monograph (Working Paper)
Language: English
Date: 7 December 2010
Place of Publication: Toulouse
Uncontrolled Keywords: Liquidity shock, Limit-orders, Asset pricing and liquidity, Algorithmic trading, Limited cognition, Sticky plans
JEL codes: D83 - Search; Learning; Information and Knowledge; Communication; Belief
G12 - Asset Pricing; Trading volume; Bond Interest Rates
Subjects: B- ECONOMIE ET FINANCE
Divisions: TSE-R (Toulouse), TSM Research (Toulouse)
Institution: Université Toulouse 1 Capitole
Site: UT1
Date Deposited: 18 Jan 2012 06:04
Last Modified: 20 Mar 2018 13:25
OAI ID: oai:tse-fr.eu:24591
URI: http://publications.ut-capitole.fr/id/eprint/3591

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