Effects of Information Overload on Financial Markets: How Much Is Too Much?
44 Pages Posted: 23 Aug 2021 Last revised: 4 Apr 2022
Date Written: April 1, 2022
Motivated by cognitive theories verifying that investors have limited capacity to process information, we study the effects of information overload on stock market dynamics. We construct an information overload index by exploiting textual analysis tools on daily data from The New York Times since 1885. Our index is associated with lower trading volume and predicts higher market returns for up to 18 months, even after controlling for standard predictors and other news-based measures. Information overload also affects the cross-section of stock returns: Investors require higher risk premia to hold small, high beta, high volatile, and unprofitable stocks. Such findings are consistent with theories emphasizing that information overload increases information and estimation risk and deteriorates investors' decision accuracy amid their limited attention.
Keywords: Sentiment, dispersion, limited attention, predicting returns
JEL Classification: G40; G41; G12; G14
Suggested Citation: Suggested Citation