Rational Inattention and Portfolio Selection

Lixin Huang () and Hong Liu

Journal of Finance, 2007, vol. 62, issue 4, pages 1999-2040

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. Copyright 2007 by The American Finance Association.

Date: 2007
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