Dynamic Attention Behavior under Return Predictability

Abstract

We investigate the dynamic problem of how much attention an investor should pay to news in order to learn about stock-return predictability and maximize expected lifetime utility. We show that the optimal amount of attention is U-shaped in the return predictor, increasing with both uncertainty and the magnitude of the predictive coefficient, and decreasing with stock-return volatility. The optimal risky asset position exhibits a negative hedging demand that is hump-shaped in the return predictor. Its magnitude is larger when uncertainty increases, but smaller when stock-return volatility increases. We test and find empirical support for these theoretical predictions.

Keywords: Optimal Attention, Portfolio Choice

JEL Classification: D53, G11, G12