Investor attention, overconfidence and category learning

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...

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Bibliographic Details
Published in:Journal of financial economics 2006-06, Vol.80 (3), p.563-602
Main Authors: Peng, Lin, Xiong, Wei
Format: Article
Language:English
Subjects:
Behavioral biases
Behavioral decision theory
Category effects
Comovement
Impact analysis
Investment policy
Limited attention
Predictions
Psychological aspects
Rational expectations
Return predictability
Studies
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Summary: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.
ISSN:0304-405X
1879-2774
DOI:10.1016/j.jfineco.2005.05.003