NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

NBER Working Papers by Lin Peng

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Working Papers

June 2005Investor Attention: Overconfidence and Category Learning
with Wei Xiong: w11400
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.

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