Asset Pricing Under Information-Processing Constraints

12 Pages Posted: 9 Nov 2008

See all articles by Yulei Luo

Yulei Luo

University of Hong Kong

Eric R. Young

University of Virginia

Date Written: January 8, 2008

Abstract

This paper studies the implications of limited information-processing capacity (also called rational inattention) for asset pricing in a linear-quadratic permanent income model. We have two main results. First, RI increases the size of the risk adjustment to asset prices by increasing the volatility and persistence of consumption growth. Second, RI increases the expected excess return. Thus, RI has the potential to play an important role in resolving extant asset pricing puzzles.

Keywords: Rational Inattention, Asset Pricing, Permanent Income

JEL Classification: G12, C61, D81, E21

Suggested Citation

Luo, Yulei and Young, Eric R., Asset Pricing Under Information-Processing Constraints (January 8, 2008). Available at SSRN: https://ssrn.com/abstract=1297849 or http://dx.doi.org/10.2139/ssrn.1297849

Yulei Luo (Contact Author)

University of Hong Kong ( email )

Pokfulam Road
Hong Kong, HK
China

Eric R. Young

University of Virginia ( email )

1400 University Ave
Charlottesville, VA 22903
United States

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