We have seen more papers refer to rational inattention models as the basis for why there are trend in prices and why expectations may be slow to adjust. This is a critical model that moves beyond the thinking of behavioral biases. Rational inattention is not a cognitive bias but the reality of how humans may process information.
Information is costly. It costs money, processing time, and most importantly, the attention we will give it. If there is more information, it will be harder to process any one piece. This applies to individuals and the market as a whole. If there is limited attention on the set of all information that can drive prices, then there will be a problem with processing. Critical information that can drive prices may not impact buyers and sellers immediately.
We have referenced this critical thinking in an earlier post:
There are now laboratory experiments that test rational inattention. The analysis has moved beyond just testing for slow adjustment but posing specific experiments on behavior that will tease out inattention and how it is addressed in a controlled manner, see "Experimental Tests of Rational Inattention". These are not easy tests to explain in a simple manner, yet the conclusions are important. Subjects adjust their attention based on incentives, but these adjustments are more than just a function of costs of information. Information impacts or changes prior beliefs, so the form of how information is collected and processed affects beliefs. Additionally, the feedback of information will matter with we give it our attention.
How investors use and process information, that is, how we give information our attention is critical. At its core, this is a simple process, but it helps drive key thinking about how markets respond to data releases.
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