Portfolio Rebalancing and Asset Pricing with Heterogeneous Inattention

Can households’ inattention to the stock market quantitatively account for the inertia in portfolio rebalancing? I address this question by introducing an observation cost into a production economy with heterogeneous agents. In this environment inattention changes endogenously over time and across agents. I find that inattention explains the inertia in portfolio rebalancing and its heterogeneity across households. Inattention also rationalises the limited stock market participation observed in the data, and improves the asset pricing performance of the model. Finally, I present a novel testable implication linking the effects of inattention on portfolio choices and asset prices to households’ funding liquidity.