Abstract
We offer a framework to simultaneously study the role played by investors’ attention to news and learning uncertainty in the determination of asset prices. We show that asset return volatility and risk premia increase quadratically with both attention and uncertainty. Our empirical investigation lends support to these theoretical predictions. Moreover, learning yields a lead-lag relation between attention and uncertainty; this relation is found to enable “panic states,” featuring spikes in volatilities and risk premia. During these panic states asset prices are very sensitive to news, consistent with recent empirical findings.
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