Retail Traders and the Competitive Allocation of Attention
Posted: 1 Nov 2014 Last revised: 17 Aug 2015
Date Written: December 17, 2014
I consider a rational expectations framework in which attention-constrained individuals compete against each other and institutions. The model reconciles a set of empirical facts that cannot be simultaneously explained by standard theories: retail trader portfolios are highly correlated, retail traders tend to follow some stocks and ignore others, and aggregate trades from retail traders are profitable over short-horizons and predict future returns (even controlling for past returns or past volume). Additionally, the equilibrium herding behavior of individuals suggests that their actions are not subsumed by institutions. Instead, the herd competes directly against institutions. The analysis also yields novel predictions regarding portfolio composition and turnover.
Keywords: Investor Attention, Rational Inattention, Retail Trade, Institutional Trade, Investor Coalitions
JEL Classification: G19, D70, G10, G14
Suggested Citation: Suggested Citation