Discrete Actions in Information-Constrained Decision Problems

Junehyuk Jung, Jeong Ho (John) Kim, Filip Matějka, Christopher A. Sims

Research output: Contribution to journalArticle

2 Scopus citations

Abstract

Individuals are constantly processing external information and translating it into actions. This draws on limited resources of attention and requires economizing on attention devoted to signals related to economic behaviour. A natural measure of such costs is based on Shannon's "channel capacity". Modelling economic agents as constrained by Shannon capacity as they process freely available information turns out to imply that discretely distributed actions, and thus actions that persist across repetitions of the same decision problem, are very likely to emerge in settings that without information costs would imply continuously distributed behaviour. We show how these results apply to the behaviour of an investor choosing portfolio allocations, as well as to some mathematically simpler "tracking" problems that illustrate the mechanism. Trying to use costs of adjustment to explain "stickiness" of actions when interpreting the behaviour in our economic examples would lead to mistaken conclusions.

Original languageEnglish (US)
Pages (from-to)2643-2667
Number of pages25
JournalReview of Economic Studies
Volume86
Issue number6
DOIs
StatePublished - Nov 1 2019

All Science Journal Classification (ASJC) codes

  • Economics and Econometrics

Keywords

  • C44
  • D01
  • D81
  • D90
  • E71
  • Rational inattention
  • decision theory
  • information theory

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