Cognitive Load and Information Processing in Financial Markets: Theory and Evidence from Disclosure Complexity

TL;DR

This paper presents a theoretical and empirical analysis of how disclosure complexity impacts investor cognition and market efficiency, revealing that higher complexity hampers price discovery especially among less sophisticated investors.

Contribution

It introduces a novel theoretical framework linking cognitive load to market inefficiencies and empirically demonstrates the effects of disclosure complexity on information processing and mispricing.

Findings

Cognitive load impairs price discovery by 18%

Less sophisticated investors are more affected by disclosure complexity

Mispricing duration increases by 23% with higher complexity

Abstract

We develop a theoretical framework for understanding how cognitive load affects information processing in financial markets and test it using exogenous variation in disclosure complexity. Our model distinguishes between attention allocation and cognitive processing capacity, showing that complex information creates differential effects across investor types. Using a comprehensive dataset of corporate disclosures and a novel identification strategy based on regulatory changes, we find that cognitive load significantly impairs price discovery, with effects concentrated among less sophisticated investors. A one-standard-deviation increase in cognitive complexity reduces information incorporation speed by 18\% and increases mispricing duration by 23\%. We provide evidence for three theoretical mechanisms: selective attention, processing errors, and strategic complexity. Our findings suggest that cognitive constraints create systematic inefficiencies in financial markets, with important implications for disclosure regulation and market design.