Rational Inattention Research Articles

Rational inattention, misallocation, and the aggregate economy

I study the effect of firm managers’ information-processing constraints on production decisions, resource misallocation, and the aggregate economy. Managers have a finite information-processing capacity to reduce uncertainty about firm-specific and economy-wide shocks. The model implies that an increase in aggregate uncertainty leads to reallocation of capacity from learning about firm-specific shocks to learning about aggregate state, leading to higher misallocation of resources and lower output. In contrast, an increase in idiosyncratic uncertainty (through an opposite mechanism) has a non-monotonic effect on aggregate productivity. The model produces new implications regarding the co-movement of inputs and Labor-TFP sensitivity which I confirm empirically.

Rational inattention when decisions take time

Decisions take time, and the time taken to reach a decision is likely to be informative about the cost of more precise judgments. We formalize this insight using a dynamic model of optimal evidence accumulation. We provide conditions under which the resulting belief dynamics resemble either diffusion processes or processes with large jumps. We then consider the in which discounting effects are small relative to the opportunity cost of time, and show that the state-contingent choice probabilities predicted by our model are identical to those predicted by a static rational inattention model, providing a micro-foundation for such models. In the diffusion case, our model provides a normative foundation for a variant of the drift-diffusion model from mathematical psychology.

Rational inattention in the frequency domain

This paper solves a dynamic rational inattention problem by formulating it in the frequency domain. The main result is a rational inattention version of the classical Wiener-Kolmogorov filter. This filter permits an infinite-dimensional state vector, provides a new line of attack for obtaining closed-form solutions, and can be implemented numerically using a simple iterative algorithm. The frequency-domain approach also sheds new light on why rational inattention produces forward-looking behavior: inattentive agents are willing to accept more uncertainty about the timing of disturbances in exchange for less uncertainty about fluctuations at the most important frequencies.

Unrestricted information acquisition

In many strategic environments, information acquisition is a central component of the game that is played. Being uncertain about a payoff‐relevant state, a player in a game has a twofold incentive to acquire information: learning the state and learning what others know. We develop a model of information acquisition in games that accounts for players' incentive to learn what others know. In applications to rational inattention and global games, we prove the power of this incentive. When information acquisition is “independent,” that is, players can acquire information only about the state, severe coordination problems emerge among rationally inattentive players. When information acquisition is “unrestricted,” that is, players can acquire information about the state and each other's information in a flexible way, we show that rational inattention admits a sharp logit characterization and we provide a new rationale for selecting risk dominant equilibria in coordination games.

Nominal Rigidities, Rational Inattention, and the Optimal Price Index Stabilization Policy

Nominal Rigidities, Rational Inattention, and the Optimal Price Index Stabilization Policy

Rational Inattention and the Business Cycle Effects of Productivity and News Shocks

Rational Inattention and the Business Cycle Effects of Productivity and News Shocks

Rational Inattention with Ambiguity Aversion

Rational Inattention with Ambiguity Aversion

Discrete Choice in Marketing through the Lens of Rational Inattention

Discrete Choice in Marketing through the Lens of Rational Inattention

Rational Inattention in the Infield

This paper provides evidence of rational inattention by experienced professionals in strategic interactions. We add rational inattention to a game of matching pennies with state-dependent payoffs. Unlike the full-information, mixed-strategy Nash equilibrium, payoffs of different actions need not be equated state by state. Moreover, players respond partially to payoff differences, this responsiveness is stronger when attention costs are lower, strategies converge to full-information Nash as stakes increase, and average payoffs across all states are approximately equal across actions. We test these predictions using data on millions of pitches from Major League Baseball, where we observe strategies, payoffs, and proxies for attention costs. (JEL C72, D83, D91, L83, Z21)

Rational Inattention as an Empirical Framework for Discrete Choice and Consumer-Welfare Evaluation

The conventional discrete-choice model of demand assumes that consumers are fully informed about every available product alternative. This assumption is at odds with the large body of literature studying incomplete information and the role of the consumer's “evoked set” or “consideration set.” The author develops a novel empirical discrete-choice demand model derived from an underlying theory of consumers' rational inattention. The model distinguishes between factors that shift demand through the utility function, such as prices and product attributes, and factors that shift demand through the consumer's information “evaluation costs.” The author conducts an empirical case study of the laundry detergent category. Using a set of exclusion restrictions based on retail promotional instruments, specification tests select the rational inattention model over the conventional full-information discrete-choice model. Exploiting the launch of Tide Pods midway through the sample, the author demonstrates the role of evaluation costs for the measured value creation from a new product. A conventional discrete-choice model always assigns positive incremental consumer value from new products. However, the rational inattention model developed herein finds a decrease in overall consumer welfare from the new Tide Pods’ entry, with the increased friction in information associated with the larger choice set offsetting the potential gains from higher match value.

Posterior Separable Cost of Information

We provide testable conditions under which the cost of acquiring information is given by the expected reduction of a measure of uncertainty (e.g., entropy). The assumption, under the name of posterior separability, is nearly universal in the literature of rational inattention; yet, a testable characterization has been lacking. In applications to experimental data, we indicate situations in which posterior separability is—and is not—a compelling assumption for the cost of information; we propose a generalization to address some of its shortcomings. We also show how to identify and estimate nonparametrically the cost of information from observable choice behavior. (JEL C91, D11, D12, D81, D91)

Effects of Monetary Policy on Household Expectations: The Role of Homeownership

We study the role of homeownership in the effectiveness of monetary policy on households' expectations. Empirically, we find that homeowners revise down their near-term inflation expectations and their optimism about future labor market conditions in response to a rise in mortgage rates, while renters are less likely to do so. We further show that the monetary-policy component of mortgage-rate changes creates the difference in expectation revisions between homeowners and renters. This result suggests that homeowners are attentive to news on interest rates and adjust their expectations accordingly in a manner consistent with the intended effect of monetary policy. We characterize these findings using a rational inattention model with two types of households---homeowners and renters.

A neural basis of rational inattention models: consistency of cognitive cost with the mutual information criterion.

The rational inattention model has recently attracted much attention as a promising candidate to model bounded rationality in the research field of decision-making and game theory. However, in contrast to this energetic promotion of the theoretical works, empirical verification of the validity of the RI model has not progressed much. Furthermore, to our knowledge, the central assumption of the RI model, that the amount of mutual information obtained from signals adequately represents the cognitive cost of information, has not been tested from a neuroscientific perspective. The purpose of the present study was to test whether the amount of mutual information adequately represents the cognitive cost of information from a neuroscientific perspective. We proposed a sequential investment task, in which the two main models of RI can be treated simultaneously in a more realistic experimental environment. We used a model-fitting approach to analyze the subjective information cost, and compared the model parameters representing the information cost with the concentration of oxidized hemoglobin in the brain blood. Our results showed that the cost parameter λ of the stochastic choice type model, which fits the behavioral data of the present experiment better than the Kalman filter type model, was significantly positively correlated with the activation status of the rostral prefrontal cortex and dorsolateral prefrontal cortex. The cognitive cost represented by the amount of mutual information employed in the RI model is consistent with the activation of brain regions associated with cognitive cost, and, thus, indirectly supports the assumption of the RI model.

Mental control of uncertainty.

Can you reduce uncertainty by thinking? Intuition suggests that this happens through the elusive process of attention: if we expend mental effort, we can increase the reliability of our sensory data. Models based on "rational inattention" formalize this idea in terms of a trade-off between the costs and benefits of attention. This paper surveys the origin of these models in economics, their connection to rate-distortion theory, and some of their recent applications to psychology and neuroscience. We also report new data from a numerosity judgment task in which we manipulate performance incentives. Consistent with rational inattention, people are able to improve performance on this task when incentivized, in part by increasing the reliability of their sensory data.

Experimental Cost of Information

We relate two main representations of the cost of acquiring information: a cost that depends on the experiment performed, as in statistical decision theory, and a cost that depends on the distribution of posterior beliefs, as in applications of rational inattention. We show that in many cases of interest, posterior-based costs are inconsistent with a primitive model of costly experimentation. The inconsistency is at the core of known limits to the application of rational inattention in games and, more broadly, in equilibrium analyses where beliefs are endogenous; we show that an experiment-based approach helps to understand and overcome these difficulties. (JEL D82, D83)

High-Frequency Effects of Novel News on the EURUSD Exchange Rate

We study the intraday relationship between novel Euro-specific news and the EURUSD exchange rate with over 100 million news articles with millisecond precision. We show a predictive but not contemporaneous relationship between these news and their sentiment and EURUSD returns. This lends support to the slow information diffusion hypothesis as well as rational inattention to new news theories. Furthermore, we identify a regime change in the relationship between news and the EURUSD returns since the Global Financial Crisis (GFC). The positive relationship observed since the GFC between news sentiment and the EURUSD was particularly prominent during the Eurozone debt crisis.

The Social Planning Problem with Costly Information Processing: Towards Understanding Production Decisions in Centralized Economies

It has long been argued that market economies feature an inherent advantage over centralized economies because they are subject to fewer information processing needs. However, very little work has investigated the role of these needs in explaining differences in optimal production decisions between centralized and market economies. This paper uses a rational inattention approach to study the decision problem of a social planner who faces uncertainty about households' preferences and can reduce this uncertainty by allocating scarce resources to processing information. The model shows that costly information processing has important implications for optimal production decisions, including for the trade‐off between consumption and leisure, the optimal range of different goods produced, and the role of correlated consumer preferences. Overall, the results suggest that differences in empirical production decisions between socialist and capitalist countries may be driven by the different information needs and associated costs of processing information inherent to each economic system, rather than by differences in ideology or political preferences.

The closer we get, the better we are?

AbstractNot always. A general requirement in models of expectations formation is that forecast accuracy should improve when getting closer to the target date. We apply a multi‐horizon bootstrap test to a unique Israeli survey of firm‐level inflation forecasts, which encompasses periods of three digits annual rates, and periods of moderate and low inflation. We find that improvements in forecast accuracy were significant during high and moderate inflation periods, but not in the low‐inflation environment. The results are in line with rational inattention, induced by a decline in inflation predictability. Further support is provided by evidence from the US SPF survey.

Retail Attention, Institutional Attention

AbstractWe document distinctly different clientele effects on investor attention and return responses to information. Macro news crowds out retail investor attention to firms’ earnings news by 49%. For stocks with high retail ownership, macro news dampens earnings announcement returns by 17% and substantially increases post-announcement drift, especially during high VIX periods. In contrast, macro news increases institutional investor attention to scheduled earnings announcements but not their attention to unscheduled analysts’ forecast revisions. The findings confirm the implications of rational inattention models and highlight the importance of considering clientele effects in understanding the effect of news on attention and asset prices.

Information Acquisition Under Resource Limitations in a Noisy Environment

We introduce a theoretical model of information acquisition under resource limitations in a noisy environment. An agent must guess the truth value of a given Boolean formula \( \varphi \) after performing a bounded number of noisy tests of the truth values of variables in the formula. We observe that, in general, the problem of finding an optimal testing strategy for \( \varphi \) is hard, but we suggest a useful heuristic. The techniques we use also give insight into two apparently unrelated but well-studied problems: (1) rational inattention , that is, when it is rational to ignore pertinent information (the optimal strategy may involve hardly ever testing variables that are clearly relevant to \( \varphi \) ), and (2) what makes a formula hard to learn/remember.