Asset Pricing Under Information-Processing Constraints

This paper studies the implications of limited information-processing capacity (also called rational inattention) for asset pricing in a linear-quadratic permanent income model. We have two main results. First, RI increases the size of the risk adjustment to asset prices by increasing the volatility and persistence of consumption growth. Second, RI increases the expected excess return. Thus, RI has the potential to play an important role in resolving extant asset pricing puzzles