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Monday, February 26, 2007

Rational and Irrational Inattention

Just saw a report of findings from a new Federal Reserve study. It reminds us of how our the flood of information has real impact on day-to-day decision-making, even in a high impact area like trading.:

Our results suggest that market participants might be focusing irrationally on the headline number, as opposed to the most precise available data in a data release.
reading the text of the data release seems to be something that should be extraordinarily easy for the markets....
Some recent research in macroeconomics and finance has discussed the possibility of "rational inattention" in which agents optimally choose not to collect information because it is costly to do so (e.g. Sims, 2006).

The discussed "rational inattention" is the fact that many of us read the subject and first couple of sentences of an email to decide what we need to do with it as quickly as posssible. We make quick choices about what's important.

The "irrational inattention" that the study discusses later is when it's not conscious choices or poor choices in this area.

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