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Investor Attention: Overconfidence and Category Learning

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Author Info
Lin Peng
Wei Xiong
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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11400.

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Date of creation: Jun 2005
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Handle: RePEc:nbr:nberwo:11400

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G0 - Financial Economics - - General
G1 - Financial Economics - - General Financial Markets

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  1. Yulei Luo, 2006. "Rational Inattention, Portfolio Choice, and the Equity Premium," Computing in Economics and Finance 2006 56, Society for Computational Economics. [Downloadable!]
  2. Christopher A. Sims, 2006. "Rational Inattention: Beyond the Linear-Quadratic Case," American Economic Review, American Economic Association, vol. 96(2), pages 158-163, May. [Downloadable!]
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