Cognitive limits and preferences for information

The structure of uncertainty underlying certain decision problems may be so complex as to elude decision makers’ full understanding, curtailing their willingness to pay for payoff-relevant information—a puzzle manifesting itself in, for instance, low stock-market participation rates. I present a decision-theoretic method that enables an analyst to identify decision makers’ information-processing abilities from observing their preferences for information. A decision maker who is capable of understanding only those events that either almost always or almost never happen fails to attach instrumental value to any information source. On the other hand, non-trivial preferences for information allow perfect identification of the decision maker’s technological capacity.