Sunday, November 27, 2011

Information and attention

Herbert A. Simon's 1971 thoughts on the economics of attention: "What information consumes is rather obvious: It consumes the attention of its recipients. Hence a wealth of information creates a poverty of attention, and a need to allocate that attention efficiently among the overabundance of information sources that might consume it."

This has been one of the more interesting quotes that I have read in the last few months. It was picked from a thoughtful article in the Journal of Finance called "In Search of Attention". This is a very innovative research piece which tries to measure the attention that is given a specific stock based on the number of hits on google. The authors find that the stocks that are given more attention will rise and that there will be a subsequent reversal. The important point is that the world of investing is overloaded with information and that investors have to learn or allocate time to any piece of information. If there is more information available, less time can be spent on any given piece of information.

"A wealth of information will create a poverty of attention." Search is one of the key activities in economics. Search is associated with attention. Attention is a scarce resource because there are limits to the amount of cognitive resources we can use at any one time.

Our attention will be focused on the "chunky news", news that will come with multiple headlines. A specific news topic like the EU crisis will have chunky news. Limited attention will lead to category-learning. (See the research "Investor Attention, Overconfidence, and Category Learning".) Investors will often allocate more time to market and sector-level information instead of firm specific information. Investors who focus on category information will often be overconfident. The overconfidence problem is more severe in diffuse tasks that require difficult judgments and do not provide good feedback. The feedback is noisy and delayed. This can represent macro information when trying to project onto firm-specific behavior. When we have more category information, we will also focus on more firm-specific information. When macro data is easy to obtained, we will then go for more specific information.

One of the reasons why I focus on models is that it can reduce the attention problem because the model will force the focus of attention to key economic variables. While this can cause problems, there will always be a specific amount of time spent on looking at key linkages.

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