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Rational Inattention and Portfolio Selection

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  • LIXIN HUANG
  • HONG LIU

Abstract

Costly information acquisition makes it rational for investors to obtain important economic news with only limited frequency or limited accuracy. We show that this rational inattention to important news may make investors over‐ or underinvest. In addition, the optimal trading strategy is “myopic” with respect to future news frequency and accuracy. We find that the optimal news frequency is nonmonotonic in news accuracy and investment horizon. Furthermore, when both news frequency and news accuracy are endogenized, an investor with a higher risk aversion or a longer investment horizon chooses less frequent but more accurate periodic news updates.

Suggested Citation

  • Lixin Huang & Hong Liu, 2007. "Rational Inattention and Portfolio Selection," Journal of Finance, American Finance Association, vol. 62(4), pages 1999-2040, August.
    • Handle: RePEc:bla:jfinan:v:62:y:2007:i:4:p:1999-2040
    DOI: 10.1111/j.1540-6261.2007.01263.x
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