In Short Supply: Efficiency Implications of Rational Attention Allocation

Abstract

This paper shows that investors allocate their scarce attention rationally. Our setting exploits the listing of options on a stock as a source of variation in the relative value of acquiring information on its industry peers. Consistent with the predictions of our theoretical model, we find that options listing is associated with a decline in attention on close industry peers. Lower attention is accompanied by a decline in trading volume and liquidity, and an increase in volatility for peer stocks. These stocks also experience a decline in stock price informativeness leading their managers to infer less information from stock prices and to a decline in firm value and profitability. Overall, our results highlight the real economic costs associated with traders’ limited attention.

Keywords: attention allocation, limited attention, information acquisition, efficiency, options listing

JEL Classification: D82, G12, G14, G31