Learning with Information Capacity Constraints

Abstract

Motivated by the fact that investors have limited time and attention in processing information, this paper provides a continuous time equilibrium model to analyze the effects of a capacity constraint in the learning process of a representative investor. Facing multiple sources of uncertainty, the investor optimally allocates her information capacity across the various sources. Consequently, the cross-sectional structure of information and the resulting asset price dynamics are determined endogenously. The model provides implications on consumption behavior and on the cross-sectional differences in price informativeness in terms of supply of information, speed of price adjustments to fundamental shocks, and price reactions to firm disclosures.

Keywords: Capacity Constraint, Attention, Learning, Information Processing, Price Informativeness

JEL Classification: D80, D83, E21, G12, G14