A Rational Inattention Perspective on Equilibrium Asset Pricing under Heterogeneous Information with Structural Breaks and Market Efficiency

In this paper we present a new model of how information travels within financial markets and present empirical evidence that the concept of attention driven information efficiency is more conjugate with market data as compared to the prevailing concept of efficient markets. Augmenting our model by a shift component made it possible to explain shifts in asset prices by a lack of attention on small permanent changes in the fundamentals. This can also be seen as a micro-level explanation of the momentum effect. By a further augmentation of the model through the introduction of heterogeneous information processing capacities we are able to give a fundamental interpretation of the financial services industry as providers of information processing capacity. Moreover, the burst of the housing bubble in the US and the successful bet of John Paulson against it are shown to be prime empirical examples of our framework.