Investor attention, overconfidence and category learning

Lin Peng, Wei Xiong

Research output: Contribution to journalArticle

382 Scopus citations

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.

Original languageEnglish (US)
Pages (from-to)563-602
Number of pages40
JournalJournal of Financial Economics
Volume80
Issue number3
DOIs
StatePublished - Jun 1 2006

All Science Journal Classification (ASJC) codes

  • Accounting
  • Finance
  • Economics and Econometrics
  • Strategy and Management

Keywords

  • Behavioral biases
  • Category effects
  • Comovement
  • Limited attention
  • Return predictability

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