@techreport{NBERw16911,
 title = "A Sparsity-Based Model of Bounded Rationality",
 author = "Xavier Gabaix",
 institution = "National Bureau of Economic Research",
 type = "Working Paper",
 series = "Working Paper Series",
 number = "16911",
 year = "2011",
 month = "March",
 URL = "http://www.nber.org/papers/w16911",
 abstract = {This paper proposes a model in which the decision maker builds an optimally simplified representation of the world which is "sparse," i.e., uses few parameters that are non-zero. Sparsity is formulated so as to lead to well-behaved, convex maximization problems. The agent's choice of a representation of the world features a quadratic proxy for the benefits of thinking and a linear formulation for the costs of thinking. The agent then picks the optimal action given his representation of the world. This model yields a tractable procedure, which embeds the traditional rational agent as a particular case, and can be used for analyzing classic economic questions under bounded rationality. For instance, the paper studies how boundedly rational agents select a consumption bundle while paying imperfect attention to prices, and how frictionless firms set prices optimally in response. This leads to a novel mechanism for price rigidity. The model is also used to examine boundedly rational intertemporal consumption problems and portfolio choice with imperfect understanding of returns.},
}