attention misallocation social welfare and policy implications we examine how agents allocate attention between private and public signals to reduce the uncertainty about observation noises when coordination is an important concern in this setting the attention allocation may not be monotone in endowed attention capacity agents may decrease their attention on or even ignore the more accurate signal when capacity increases as a result social welfare may decrease when they have more attention to process information and it can be even higher when agents possess a finite amount of capacity than when they have an infinite amount of capacity we derive sufficient and necessary conditions under which multiple equilibria emerge and study the implications of equilibrium multiplicity for macroeconomic policies

information acquisition and under diversification if an investor wants to form a portfolio of risky assets and can exert effort to collect information on the future value of these assets before he invests which assets should he learn about the best assets to acquire information about are ones the investor expects to hold but the assets the investor holds depend on the information he observes we build a framework to solve jointly for investment and information choices with general preferences and information cost functions although the optimal research strategies depend on preferences and costs the main result is that the investor who can first collect information systematically deviates from holding a diversified portfolio information acquisition can rationalize investing in a diversified fund and a concentrated set of assets an allocation often observed but usually deemed anomalous copyright wiley blackwell

bilateral portfolio dynamics during the global financial crisis abstract there has been considerable bilateral variation in the pattern of portfolio capital flows during the global financial crisis for a given destination investors from different countries adjusted their holdings to different degrees we show that the size of the initial bilateral holding geographical distance common language the level of trade and common institutional linkages help to explain the pattern of adjustment these bilateral factors are more important for equities than for bonds and for investors from developing countries than for investors from advanced countries

growth forecasts belief manipulation and capital markets abstract we analyze how a benevolent privately informed government agency would optimally release information about the economy s growth rate when the agents hold heterogeneous beliefs we model two types of agent conforming and dissenting the former has a prior that is identical to that of the government agency whereas the latter has a prior that differs from that of the government agency we identify both informative and uninformative equilibria informative equilibria are equilibria in which the government agency s equilibrium signal leads to a revision of beliefs we demonstrate that the uninformative equilibria can in fact dominate the informative ones in terms of ex post social welfare

trying to explain home bias in equities and consumption investors hold a substantially larger proportion of their wealth portfolios in domestic assets than standard portfolio theory would suggest a phenomenon called equity home bias in the absence of this bias investors would optimally diversify domestic output risk using foreign equities therefore consumption growth rates would tend to co move across countries even when output growth rates do not empirically however consumption growth rates tend to have a lower correlation across countries than do output growth rates a phenomenon i call consumption home bias in this paper i discuss these two biases and their potential relationship as suggested by the literature

the value of diffusing information abstract how does the speed by which information diffuses affect its value to a stock market investor in a structural model solved in closed form this speed has two opposing effects on the empirically dominant term of the value of information faster diffusing information means quicker and less noisy profits but also increases competing informed trading impounding more information into prices and eroding profits structural empirical analysis of stock market reaction to drug approvals using media coverage as a proxy for the transmission rate of information finds that the value of information is hump shaped in its future transmission rate moreover the estimated amount of noise trading is small

quantifying the risk sharing welfare gains of social security the welfare effects of intergenerational risk sharing through a pay as you go social security system that is efficiently indexed to wages or interest rates are quantified comparing steady states there are large welfare gains of being born into an economy with efficient risk sharing as compared to the current u s system efficient policy involves an increasingly risky net of tax income over the life cycle when adjustment to steady state is taken into account the welfare gains largely turn negative the results are also compared and contrasted to the first best allocation

can information heterogeneity explain the exchange rate determination puzzle empirical evidence shows that most exchange rate volatility at short to medium horizons is related to order flow and not to macroeconomic variables we introduce symmetric information dispersion about future macroeconomic fundamentals in a dynamic rational expectations model in order to explain these stylized facts consistent with the evidence the model implies that a observed fundamentals account for little of exchange rate volatility in the short to medium run b over long horizons the exchange rate is closely related to observed fundamentals c exchange rate changes are a weak predictor of future fundamentals and d the exchange rate is closely related to order flow

knowing what others know coordination motives in information acquisition we explore how optimal information choices change the predictions of strategic models when a large number of agents play a game with strategic complementarity information choices exhibit complementarity as well if an agent wants to do what others do they want to know what others know this makes heterogeneous beliefs di cult to sustain and may generate multiple equilibria in models with substitutability agents prefer to difierentiate their information choices we use these theoretical results to examine the role of information choice in recent price setting models and to propose modeling techniques that ensure equilibrium uniqueness

taking gravity online the role of virtual proximity in international finance abstract this paper analyses international patterns of bilateral portfolio equity and debt investment in a gravity model framework we contribute to the literature by exploring the role of virtual proximity measured by bilateral internet hyperlinks between countries as a novel proxy for cross border information flows and cultural proximity more generally our findings show that bilateral portfolio investment is significantly affected by virtual proximity indicating that countries which are more closely connected in terms of web content are more integrated financially the effect is stronger for equity than for debt investment highlighting the larger information sensitivity of equity investments and is largest for investments among advanced economies moreover including virtual proximity in estimations reduces the importance of traditionally used proxies for information asymmetries and cultural proximity

asymmetric price movements and borrowing constraints a rational expectations equilibrium model of crises contagion and confusion this study proposes a rational expectations equilibrium model of crises and contagion in an economy with information asymmetry and borrowing constraints consistent with empirical observations the model finds 1 crises can be caused by small shocks to fundamentals 2 market return distributions are asymmetric and 3 correlations among asset returns tend to increase during crashes the model also predicts 1 crises and contagion are likely to occur after small shocks in the intermediate price region 2 the skewness of asset price distributions increases with information asymmetry and borrowing constraints and 3 crises can spread through investor borrowing constraints

implications of rational inattention abstract a constraint that actions can depend on observations only through a communication channel with finite shannon capacity is shown to be able to play a role very similar to that of a signal extraction problem or an adjustment cost in standard control problems the resulting theory looks enough like familiar dynamic rational expectations theories to suggest that it might be useful and practical while the implications for policy are different enough to be interesting

the determinants of cross border equity flows abstract we explore a new panel data set on bilateral gross cross border equity flows between 14 countries 1989 1996 we show that a gravity model explains international transactions in financial assets at least as well as goods trade transactions gross transaction flows depend on market size in source and destination country as well as trading costs in which both information and the transaction technology play a role distance proxies some information costs and other variables explicitly represent information transmission an information asymmetry between domestic and foreign investors and the efficiency of transactions the geography of information is the main determinant of the pattern of international transactions while there is weak support in our data for the diversification motive once we control for the informational friction we broaden the scope of our results by presenting some evidence linking the results on equity transactions to equity holdings

limited investor attention and the mispricing of american depositary receipts abstract i test whether more investor attention leads to a better exploitation of arbitrage opportunities and in turn to less mispricing of american depositary receipts adrs using data on 536 stocks i find that more investor attention significantly reduces adr mispricing

international capital flows under dispersed private information abstract it is well established that private information is critical to our understanding of asset prices in this paper we argue that it also affects international capital flows and use a simple two country dsge model to illustrate its impact we show that private information i increases the volatility of both net and gross capital flows ii leads to a high correlation between capital inflows and outflows iii leads to a disconnect of capital flows from observed macro fundamentals and iv implies that capital flows contain information about the future macro fundamentals we also show that dispersed information affects capital flows both through asset prices and directly so that the impact on flows is not just the mirror image of the impact on prices

model misspecification and underdiversification in this paper we study intertemporal portfolio choice when an investor accounts explicitly for model misspecification we develop a framework that allows for ambiguity about not just the joint distribution of returns for all stocks in the portfolio but also for different levels of ambiguity for the marginal distribution of returns for any subset of these stocks we find that when the overall ambiguity about the joint distribution of returns is high then small differences in ambiguity for the marginal return distribution will result in a portfolio that is significantly underdiversified relative to the standard mean variance portfolio

portfolio choice attention allocation and price comovement abstract this paper models the attention allocation of portfolio investors investors choose the composition of their information subject to an information flow constraint given their expected investment strategy in the next period which is to hold a diversified portfolio in equilibrium investors choose to observe one linear combination of asset payoffs as a private signal when investors use this private signal to update information about two assets changes in one asset affect both asset prices and may lead to asset price comovement the model also has implications for the transmission of volatility shocks between two assets

home bias in open economy financial macroeconomics standard theory would predict that investors hold a well diversified portfolio of equities across the world but despite the process of financial globalization investors still hold a disproportionate share of local equities in their portfolio the equity home bias french and poterba 1991 we review the various explanations of this puzzling phenomenon in the context of recent developments in macroeconomic modelling that have allowed to incorporate sophisticated international portfolio choices in standard two country general equilibrium models we refer to this literature as open economy financial macroeconomics we focus on three broad classes of explanations i hedging motives in frictionless financial markets real exchange rate and non tradable income risk ii asset trade costs in international financial markets such as transaction costs differences in tax treatments between national and foreign assets iii informational frictions and behavioural biases these recent developments raise the need for new portfolio facts beyond the equity home bias and we will present some new evidence on cross border asset holdings across different types of assets equities bonds and bank lending we also present some new micro data on institutional holdings of equity at the fund level these data should inform macroeconomic modelling of the open economy and a growing literature of models of delegated investment

short sale constraints information acquisition and asset prices abstract during financial crises financial market regulators often restrict short selling to support prices and curb volatility however evidence suggests that short selling bans during the turmoil in financial markets in 2007 2009 failed to achieve regulators goals we analyze a model of costly private information acquisition and asset pricing under short sale constraints to examine a possible cause of this failure we show that the constraints increase return volatility by adversely affecting the production of private information when investors are highly risk averse or are holding highly correlated risky assets the distortion in private information production arising from imposing short sale constraints leads to undervaluation implying that imposing short selling bans during economic crises not only fails to curb volatility but also may fail to support prices

limited information capacity as a source of inertia abstract we derive optimal time dependent adjustment rules from shannon s 1948 information theory in a continuous time lq prediction problem with a costly rate of information acquisition processing the optimal prediction evolves smoothly but jumps at an optimally chosen frequency when fresh information accrues a more volatile and persistent target raises the information rate required to maintain a sampling frequency this cost effect moderates and may even reverse the benefit effect on the value of information so optimal inertia is unresponsive to and nonmonotonic in the predictability of the environment conventional models with a fixed cost per observation imply no such cost effect so inertia rises quickly in the predictability of the environment

do domestic investors have an information advantage evidence from indonesia using transaction data from the jakarta stock exchange i find three pieces of evidence which indicate that domestic investors have an information advantage over foreign investors first foreign investors systematically buy at higher and sell at lower intra day prices than domestic investors second foreign investors tend to sell prior to large positive returns finally the permanent impact of foreign purchases is smaller than that of domestic purchases over time prices at which foreign investors trade have worsened while foreign selling prior to positive returns has disappeared

equity home bias and corporate disclosure abstract i show that more comprehensive corporate disclosure reduces investors uncertainty about domestic companies payoffs at no cost thereby decreasing investors equity home bias toward a country since investors should base their investment decisions on valid and easily interpretable company information only more comprehensive disclosure will reduce the home bias only if domestic securities law is sufficiently stratified and domestic companies use international accounting standards using panel data for 38 countries from 2003 to 2008 i find that more comprehensive disclosure reduces investors home bias though significantly only for countries that sufficiently enforce their securities law and implement international accounting standards

direct and indirect sale of information the authors compare two methods for a monopolist to sell information to traders in a financial market in a direct sale information buyers observe versions of the seller s signal while in an indirect sale the seller sells shares in a portfolio based on his private information it is shown that when traders are identical and pricing is linear there is a trade off between optimal surplus extraction that is possible under direct sale and more effective control of the usage of information that is possible under indirect sale the optimal selling method depends on how much information is revealed by equilibrium prices copyright 1990 by the econometric society

information immobility and the home bias puzzle many argue that home bias arises because home investors can predict home asset payoffs more accurately than foreigners can but why does global information access not eliminate this asymmetry we model investors endowed with a small home information advantage who choose what information to learn before they invest surprisingly even when home investors can learn what foreigners know they choose not to investors profit more from knowing information others do not know learning amplifies information asymmetry the model matches patterns of local and industry bias foreign investments portfolio outperformance and asset prices finally we propose new avenues for empirical research

rational contagion and the globalization of securities markets this paper argues that globalization may promote contagion by weakening incentives for gathering costly information and by strengthening incentives for imitating arbitrary market portfolios in the presence of short selling constraints the gain of gathering information at a fixed cost may diminish as markets grow moreover if a portfolio manager s marginal cost for yielding below market returns exceeds the marginal gain for above market returns there is a range of optimal portfolios in which all investors imitate arbitrary market portfolios and this range widens as the market grows numerical simulations suggest that these frictions can have significant implications for capital flows in emerging markets

robustly strategic consumption portfolio rules with informational frictions this paper provides a tractable continuous time constant absolute risk aversion gaussian framework to explore how the interactions of fundamental uncertainty model uncertainty due to a preference for robustness and state uncertainty due to information processing constraints rational inattention affect strategic consumption portfolio rules and precautionary savings in the presence of uninsurable labor income specifically after solving the model explicitly i compute and compare the elasticities of strategic asset allocation and precautionary savings to risk aversion robustness and inattention furthermore for plausibly estimated and calibrated model parameters i quantitatively analyze how the interactions of model uncertainty and state uncertainty affect the optimal share invested in the risky asset and show that they can provide a potential explanation for the observed stockholding behavior of households with different education and income levels this paper was accepted by neng wang finance

information and capital flows the determinants of transactions in financial assets abstract we show that a gravity model explains international transactions in financial assets at least as well as goods trade transactions our results support the hypothesis that informational asymmetries are responsible for the strong negative relationship between asset trade and distance this result is very important for theories of asset trade portfolio adjustments and home bias we strengthen it by investigating the roles of explicit informational variables as well as distance in explaining separately cross border trade in corporate equities corporate bonds and government bonds

revealed preference rational inattention and costly information acquisition we develop a revealed preference test for optimal acquisition of costly information the test encompasses models of rational inattention sequential signal processing and search we provide limits on the extent to which attention costs can be recovered from choice data we experimentally elicit state dependent stochastic choice data of the form the tests require in simple cases tests con rm that subjects adjust their attention in response to incentives as the theory dictates

human capital and imperfectly informed financial markets deviating from conventional models in financial economics which maintain that markets are perfectly informed more recent work has relied on the role of private information to explain observed portfolio choices or their impact on market outcomes in financial and currency markets see e g philippe bacchetta and eric van wincoop 2006 and stijin van nieuwerburgh and laura veldkamp 2009 these studies have not offered however a testable model of endogenous information acquisition following isaac ehrlich william a hamlen jr and yong yin 2008 we here pursue such a model based on the role of human capital in information production and test its power to explain variations in home bias the holding of home relative to foreign stocks across international markets there is an extensive literature in financial economics that offers various explanations for home bias what we add to these studies is the role of prior knowledge and private information acquisition in imperfectly informed markets our model of endogenous information acquisition or asset management cf ehrlich and uri ben zion 1976 relies on heterogeneity in individuals human capital endowments both general and specific to explain evidence on diversity in home bias at both the micro and macro levels in a multiasset framework our model predicts that while a conditional increase in general human capital proxied by schooling increases the expected absolute demand for both home and foreign stocks home bias at the market level is an inverted u function of schooling this prediction is confirmed in our empirical investigation human capital and imperfectly informed financial markets

location matters an examination of trading profits the electronic trading system xetra of the german security exchange provides a unique data source on the equity trades of 756 professional traders located in 23 different cities and eight european countries we explore informational asymmetries across the trader population traders located outside germany in non german speaking cities show lower proprietary trading profit their underperformance is not only statistically significant it is also of economically significant magnitude and occurs for the 11 largest german blue chip stocks we also examine whether a trader location in frankfurt as the financial center or local proximity of the trader to the corporate headquarters of the traded stock or affiliation with a large financial institution results in superior trading performance the data provide no evidence for a financial center advantage or of increasing institutional scale economies in proprietary trading however we find evidence for an information advantage due to corporate headquarters proximity for high frequency intraday trading

diversification as a public good community effects in portfolio choice within a rational general equilibrium model in which agents care only about personal consumption we consider a setting in which due to borrowing constraints individuals endowed with local resources underparticipate in financial markets as a result investors compete for local resources through their portfolio choices even with complete financial markets and no aggregate risk agents may herd into risky portfolios this yields a pareto dominated outcome as agents introduce community risk unrelated to fundamentals moreover if some agents are behaviorally biased or cannot completely diversify their holdings rational agents may choose more extreme portfolios and amplify the effect

financial education and behavioral finance new insights into the role of information in financial decisions recent empirical evidence based on surveys and experimental activities within the fields of behavioral finance and financial education has offered economists new empirically based insights into how individuals use information in making financial decisions specifically the importance of information in financial decisions may be reduced or eliminated by psychological aspects of the individual such as a state of overconfidence that is individual or shared with a group or by the individual s limited ability to process complex and abundant information this paper aims to complement this emerging body of literature by studying how individuals perceive and process information when making financial decisions we review these contributions and suggest a number of broad guidelines that can provide a framework for future discussion of this topic within financial decision theory

the determinants of international investment and attention allocation using internet search query data abstract this paper explores the joint determination of home bias and attention allocation we overcome the typical challenge associated with evaluating attention allocation theories by using a new internet search query dataset to measure how much information investors decide to process employing an instrumental variables approach we find empirical evidence of a two way causality between home bias and attention our estimates suggest that if all countries were to receive the same level of attention as the u s then the average home bias by u s investors would fall from 85 2 to 57 3

loyalty based portfolio choice i evaluate the effect of loyalty on individuals portfolio choice using a unique dataset of retirement contributions i exploit the statutory difference that in 401 k plans stand alone employees can invest directly in their division while conglomerate employees must invest in the entire firm including all unrelated divisions consistent with loyalty employees of stand alone firms invest 10 percentage points 75 more in company stock than conglomerate employees support is also found using variation in loyalty between different groups of employees across and within firms the cost to employees of loyalty is large amounting to nearly a 20 loss in retirement income

hedging familiarity and portfolio choice we exploit the restrictions of intertemporal portfolio choice in the presence of non nancial income risk to design and implement tests of hedging that use the information contained in the actual portfolio of the investor we use a unique dataset of swedish investors with information broken down at the investor level and into various components of wealth investor income tax positions and investor demographic characteristics portfolio holdings are identi ed at the stock level we show that investors do not engage in hedging but invest in stocks closely related to their non nancial income we explain this with familiarity that is the tendency to concentrate holdings in stocks with which the investor is familiar in terms of geographical or professional proximity or that he has held for a long period we show that familiarity is not a behavioral bias but is information driven familiarity based investment allows investors to earn higher returns than they would have otherwise earned if they had hedged

the puzzling evolution of the home bias information processing and financial openness abstract this paper explains the home equity bias and its puzzling evolution in a model where investors face an information constraint and have an initial local informational advantage after financial liberalization local investors have a magnified informational advantage since information processed under autarky remains useful after liberalization a gradual shift towards foreign assets occurs as the relevance of autarkic information declines over time in the long run home bias remains large due to the interaction between information and portfolio choices empirical evidence supports the main predictions of our model namely that bias increases with information capacity and decreases with financial openness

restoring rational choice the challenge of consumer financial regulation abstract this lecture considers the case for consumer financial regulation in an environment where many households lack the knowledge to manage their financial affairs effectively the lecture argu

feedback effects and asset prices feedback effects from asset prices to firm cash flows have been empirically documented this finding raises a question for asset pricing how are asset prices determined if price affects fundamental value which in turn affects price in this environment by buying assets that others are buying investors ensure high future cash flows for the firm and subsequent high returns for themselves hence investors have an incentive to coordinate which may generate self fulfilling beliefs and multiple equilibria using insights from global games we pin down investors beliefs analyze equilibrium prices and show that strong feedback leads to higher excess volatility

why do retired workers claim their social security benefits so early a potential explanation based on the cumulative prospect theory abstractsocial security provides longevity insurance for older americans according to expected utility theory models rational households who are not liquidity constrained should delay claiming th

risk versus ambiguity and international security design abstract we study portfolio allocation and characterize contracts issued by firms in the international financial market when investors exhibit ambiguity aversion and perceive ambiguity in assets issued in foreign locations increases in the variance of their risky production process cause firms to issue assets with a higher variable payment equity hikes in investors perceived ambiguity have the opposite effect and lead to less risk sharing entrepreneurs from capital scarce countries finance themselves relatively more through debt than equity they are thus exposed to higher volatility per unit of consumption the expected returns on capital invested in capital scarce countries may also be lower such results do not hold in the absence of ambiguity that is when investors only perceive risk new facts uncovered from cross country firm level data are consistent with our model

information acquisition and learning from prices over the business cycle abstract we study firms incentives to acquire costly information in booms and recessions to investigate the role of endogenous information in accounting for business cycles our model predicts that for a wide range of parameter values firms have a stronger incentive to acquire information when the economy has been in a recession and a pessimistic belief about the state of the economy prevails than after a boom when firms share an optimistic belief the equilibrium price system which features endogenous information transmission dampens aggregate fluctuations by discouraging information acquisition our welfare analysis reveals that information acquisition in the decentralized economy is not efficient this is due to inefficient employment dispersion arising from information heterogeneity in equilibrium time series data for the u s economy support the model s prediction of wages being more informative about total factor productivity after recessions than following booms

optimal sticky prices under rational inattention this paper presents a model in which price setting firms decide what to pay attention to subject to a constraint on information flow when idiosyncratic conditions are more variable or more important than aggregate conditions firms pay more attention to idiosyncratic conditions than to aggregate conditions when we calibrate the model to match the large average absolute size of price changes observed in micro data prices react fast and by large amounts to idiosyncratic shocks but only slowly and by small amounts to nominal shocks nominal shocks have strong and persistent real effects we use the model to investigate how the optimal allocation of attention and the dynamics of prices depend on the firms environment jel e 3 e5 d8

on the use and misuse of profit functions for measuring the price responsiveness of peasant farmers a comment the standard profit function approach has been applied successfully in a number of ldcs to measure the price responsiveness of peasant farmers yet various problems afflict this approach including but not restricted to the existence of non competitive market structures zero valued observations exclusion of relevant variables lack of participation in output and or input markets and endogeneity of input and or output prices the impact of these problems on estimation results however can be minimised through modifications and adaptations of the standard approach better specification of the underlying technology and the use of selected functional forms

optimality of debt under flexible information acquisition we study the optimality of debt through the interaction between se curity design and information acquisition an impatient seller designs an asset backed security and a buyer decides whether to buy it to provide liquidity facing dierent securities the buyer has incentives to acquire in formation from dierent aspects of the fundamental which in turn aects security design speci cally the buyer bene ts from information acqui sition at the expense of the seller through adverse selection the seller hence deliberately designs the security to induce the buyer to acquire the information least harmful to the seller s interest since securities can be designed in arbitrary ways the resulting incentive to acquire information is very exible thus we introduce exible information acquisition to capture this interaction we show that debt is uniquely optimal com pared with the security design literature we neither assume monotonicity of the feasible securities nor impose various distributional assumptions on the fundamental or information structures fixed aggregate cash ow and homogeneous information cost are two key factors driving the results jel d86 d82 g32

induced uncertainty market price of risk and the dynamics of consumption and wealth abstract in this paper we examine the implications of model uncertainty or robustness rb for consumption and saving and the market price of uncertainty under limited information processing capacity rational inattention or ri first we show that ri by itself creates an additional demand for robustness that leads to higher induced uncertainty facing consumers second if we allow capacity to be elastic rb increases the optimal level of attention third we explore how the induced uncertainty composed of i model uncertainty due to rb and ii state uncertainty due to ri affects consumption and wealth dynamics the market price of uncertainty and the welfare losses due to incomplete information we find that induced uncertainty can better explain the observed consumption income volatility and market price of uncertainty low attention increases the effect of model misspecification

information aggregation in a noisy rational expectations economy abstract this paper analyzes a general equilibrium model of a competitive security market in which traders possess independent pieces of information about the return of a risky asset each trader conditions his estimate of the return both on his own private source of information and price which in equilibrium serves as a noisy aggregator of the total information observed by all traders a closed form characterization of the rational expectations equilibrium is presented a counter example to the existence of fully revealing equilibrium is developed