Working Paper: NBER ID: w26743
Authors: Benjamin M. Hbert; Michael Woodford
Abstract: We derive a new cost of information in rational inattention problems, the neighborhood-based cost functions, starting from the observation that many settings involve exogenous states with a topological structure. These cost functions are uniformly posterior-separable and capture notions of perceptual distance. This second property ensures that neighborhood-based costs, unlike mutual information, make accurate predictions about behavior in perceptual experiments. We compare the implications of our neighborhood-based cost functions with those of the mutual information in a series of applications: perceptual judgments; the general environment of binary choice; regime-change games; and linear-quadratic-Gaussian settings.
Keywords: Information Costs; Rational Inattention; Perceptual Judgments; Neighborhood-Based Cost Functions
JEL Codes: D83; G41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| neighborhood-based costs (R20) | behavior in perceptual experiments (C99) |
| mutual information (D83) | behavior in perceptual experiments (C99) |
| neighborhood-based costs (R20) | continuous response frequencies in decision-making (D91) |
| mutual information (D83) | discrete jumps in decision-making (D91) |
| neighborhood-based costs (R20) | unique equilibrium in regime-change games (C73) |
| nature of information costs (D83) | decision-making process in regime-change games (D70) |
| neighborhood-based costs (R20) | efficiency in games with rationally inattentive agents (C73) |
| neighborhood-based costs (R20) | volatility in games with rationally inattentive agents (C73) |