In Short Supply: Efficiency Implications of Rational Attention Allocation

Abstract

This paper examines the role of rational attention allocation in shaping private information acquisition, and its implications for price informativeness and real outcomes. Our setting exploits the listing of options on a stock as a source of variation in the relative value of acquiring information on its close industry peers. Consistent with the predictions of our theoretical model, we find that options listing is associated with a decline in attention, trading volume, and liquidity, and an increase in volatility for peer stocks. These peer firms further experience a decline in stock price informativeness, 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, G14, G12, G31