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Most theories in economics and finance predict what people will do, given what they know about the world around them. But what do people know about their environments? The study of information choice seeks to answer this question, explaining why economic players know what they know--and how the information they have affects collective outcomes. Instead of assuming what people do or don't know, information choice asks what people would choose to know. Then it predicts what, given that information, they would choose to do. In this textbook, Laura Veldkamp introduces graduate students in economics and finance to this important new research.
The book illustrates how information choice is used to answer questions in monetary economics, portfolio choice theory, business cycle theory, international finance, asset pricing, and other areas. It shows how to build and test applied theory models with information frictions. And it covers recent work on topics such as rational inattention, information markets, and strategic games with heterogeneous information.
Acknowledgments ix
PART I: PRELIMINARIES 1
Chapter 1: Why Study Information Choice? 3
1.1 Types of Learning Models 4
1.2 Themes That Run through the Book 5
1.3 Organization of the Book 8
Chapter 2: Bayesian Updating 11
2.1 Normal Random Variables 11
2.2 Uniform Random Variables 13
2.3 The Kalman Filter 13
2.4 Bayesian Updating in Continuous Time 15
2.5 Mathematical References 16
2.6 Exercises 16
Chapter 3: Measuring Information Flows 17
3.1 Preliminaries 17
3.2 Entropy and Rational Inattention 18
3.3 Additive Cost in Signal Precision 20
3.4 Diminishing Returns to Learning and Unlearnable Risk 21
3.5 Inattentiveness 22
3.6 Recognition 22
3.7 Information-Processing Frictions 23
3.8 Learning When Outcomes Are Correlated 23
3.9 What Is the Right Learning Technology? 26
3.10 Appendix: Matrix Algebra and Eigen-Decompositions 27
3.11 Exercises 27
Chapter 4: Games with Heterogeneous Information 29
4.1 Preliminary Concepts 29
4.2 Heterogeneous Information Eliminates Multiple Equilibria 30
4.3 Information and Covariance: A Beauty Contest Model 33
4.4 Strategic Motives in Information Acquisition 36
4.5 Example: Information Choice and Real Investment 39
4.6 Public Information Acquisition and Multiple Equilibria 42
4.7 Broader Themes and Related Literature 44
4.8 Exercises 45
PART II: INFORMATION CHOICE WITH COMPLEMENTARITY IN ACTIONS 47
Chapter 5: Disclosing Public Information 49
5.1 Payoff Externalities and the Social Value of Information 49
5.1.1 Coordination and Overreaction to Public Information 49
5.1.2 Morris and Shin's Social Cost of Public Information 50
5.1.3 Can Private Information Also Be Socially Costly? 51
5.1.4 A More General Approach 52
5.1.5 The Central Bank Transparency Debate 53
5.2 Public Information Crowds Out Private Information 53
5.2.1 Amador and Weill 2009 53
5.2.2 Complementary Public and Private Information 55
5.2.3 Private Information Makes Public Disclosures More
Informative 57
5.3 More Information Increases Price Volatility 58
5.4 Public Information Makes Money Neutral 59
5.5 Broader Themes and Paths for Future Research 59
5.5.1 Speculative Currency Attacks 60
5.5.2 A Coordination-Based Theory of Leadership 61
5.6 Exercises 62
Chapter 6: Informational Inertia and Price-Setting 63
6.1 Lucas-Phelps Model 64
6.2 A Recipe for Inertia 67
6.3 Inattentiveness in Price-Setting 69
6.4 Rational Inattention Models of Price-Setting 72
6.5 Are Prices State Dependent or Time Dependent? 76
6.6 Broader Themes and Paths for Future Research 80
6.7 Exercises 82
PART III: INFORMATION CHOICE WITH SUBSTITUTABILITY IN ACTIONS 83
Chapter 7: Information Choice and Investment Choice 85
7.1 A One-Asset Model with Information Choice 86
7.2 Multiple Assets and Exogenous Information 91
7.3 Multiple Assets with Information Choice 94
7.3.1 Gains to Specialization 95
7.3.2 Identical Investors Hold Different Portfolios 96
7.4 Interpreting Information Constraints in Equilibrium 97
7.5 Broader Themes and Paths for Future Research 99
7.6 Appendix: Computing Expected Utility 101
7.7 Appendix: Correlated Assets 104
7.8 Exercises 105
Chapter 8: Returns to Scale in Information 107
8.1 Returns to Scale in Real Investment (One Asset) 108
8.2 Gains to Specialization (N Assets) 110
8.2.1 Result: Optimal Portfolio Choice 112
8.2.2 Result: Optimal Information Choice 113
8.2.3 Indifference Results 114
8.2.4 Preference for Early Resolution of Uncertainty 115
8.3 Markets for Information 116
8.4 Broader Themes 119
8.5 Paths for Future Research 120
8.6 Exercises 123
Chapter 9: Information as an Aggregate Shock 124
9.1 News about Future Productivity 125
9.1.1 Model 1: Cross-Industry Complementarity 125
9.1.2 Model 2: Gradual Capital Adjustment 127
9.1.3 Matching Stock Market Fluctuations 128
9.1.4 Empirical Evidence on News Shocks 129
9.2 News about Current Productivity 130
9.2.1 Model 3: Aggregate News Shocks 130
9.2.2 Model 4: Confusing Private and Public News 133
9.3 Broader Themes and Paths for Future Research 137
9.4 Exercises 138
PART IV: MEASUREMENT 141
Chapter 10: Testing Information Theories 143
10.1 Measuring Flows of News 143
10.2 Forecast Precision 144
10.3 Using Covariances to Infer Information Sets 145
10.4 Realized Profits as Proxies for Information 146
10.5 Information Choice as a Substitute for Information Data 146
10.6 The Bid-Ask Spread and PIN 149
Chapter 11: Conclusions 152
References 153
Index 165
Overview
Most theories in economics and finance predict what people will do, given what they know about the world around them. But what do people know about their environments? The study of information choice seeks to answer this question, explaining why economic players know what they know--and how the information they have affects collective outcomes. Instead of assuming what people do or don't know, information choice asks what people would choose to know. Then it predicts what, given that information, they would ...