Background: A large body of evidence suggests impaired context processing in schizophrenia. Here we propose that this impairment arises from defective integration of mediotemporal 'what' and 'where routes, carrying object and spatial information to the hippocampus. Methodology and Findings: We have previously shown, in a mediotemporal lobe (MTL) model, that the abnormal connectivity between MTL regions observed in schizophrenia can explain the episodic memory deficits associated with the disorder. Here we show that the same neuropathology leads to several context processing deficits observed in patients with schizophrenia: 1) failure to choose subordinate stimuli over dominant ones when the former fit the context, 2) decreased contextual constraints in memory retrieval, as reflected in increased false alarm rates and 3) impaired retrieval of contextual information in source monitoring. Model analyses show that these deficits occur because the 'schizophrenic MTL forms fragmented episodic representations, in which objects are overrepresented at the expense of spatial contextual information. Conclusions and Significance: These findings highlight the importance of MTL neuropathology in schizophrenia, demonstrating that it may underlie a broad spectrum of deficits, including context processing and memory impairments. It is argued that these processing deficits may contribute to central schizophrenia symptoms such as contextually inappropriate behavior, associative abnormalities, conversational drift, concreteness and delusions. © 2009 Talamini et al.