Investor Attention, Overconfidence and Category Learning

Posted: 29 Aug 2005

See all articles by Lin Peng

Lin Peng

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance

Wei Xiong

Princeton University - Department of Economics; National Bureau of Economic Research (NBER)

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Abstract

Motivated by psychological evidence that attention is a scarce cognitive resource, we model investors' attention allocation in learning and study the effects of this on asset-price dynamics. We show that limited investor attention leads to "category-learning behavior", i.e., investors tend to process more market and sector-wide information than firm-specific information. This endogenous structure of information, when combined with investor overconfidence, generates important features observed in return comovement that are otherwise difficult to explain with standard rational expectations models. Our model also demonstrates new cross-sectional implications for return predictability.

Keywords: Limited Attention, Category Effects, Behavioral Biases, Comovement, Return Predictability

JEL Classification: G12, G14

Suggested Citation

Peng, Lin and Xiong, Wei, Investor Attention, Overconfidence and Category Learning. Journal of Financial Economics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=788890

Lin Peng (Contact Author)

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance ( email )

17 Lexington Avenue
New York, NY 10010
United States

Wei Xiong

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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