Working Paper: NBER ID: w11400
Abstract: Motivated by psychological evidence that attention is a scarce cognitive resource, we model investors' attention allocation in learning and study the effects of this on asset-price dynamics. We show that limited investor attention leads to ``category-learning" behavior, i.e., investors tend to process more market and sector-wide information than firm-specific information. This endogenous structure of information, when combined with investor overconfidence, generates important features observed in return comovement that are otherwise difficult to explain with standard rational expectations models. Our model also demonstrates new cross-sectional implications for return predictability.
Keywords: Investor Attention; Overconfidence; Category Learning; Asset Pricing
JEL Codes: G0; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| limited investor attention (G40) | attention to market and sector-level factors (L10) |
| attention to market and sector-level factors (L10) | category-learning behavior (C92) |
| category-learning behavior (C92) | higher return correlations among firms (G32) |
| improvement in information technology (L86) | attention to firm-specific information (L20) |
| attention to firm-specific information (L20) | reduced return correlations (C10) |
| overconfidence in information processing (D83) | overreactions in asset prices (G19) |
| overreactions in asset prices (G19) | predictability in returns (G17) |
| limited investor attention (G40) | return comovement (C10) |