Limited Attention and the Allocation of Effort in Securities Trading

Abstract

While limited attention has been analyzed in a variety of economic and psychological settings, its impact on financial markets is not well understood. In this paper, we examine individual NYSE specialist portfolios and test whether liquidity provision is affected as specialists allocate their attention across stocks. Our results indicate that specialists allocate effort toward their most active stocks during periods of increased activity, resulting in less frequent price improvement and increased transaction costs for their remaining assigned stocks. Thus, the allocation of effort due to limited attention has a significant impact on liquidity provision in securities markets.

Keywords: Limited Attention, Microstructure, Specialists, Transaction Costs

JEL Classification: D23, G14, J22