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Rational Inattention in Uncertain Business Cycles
Author(s) -
ZHANG FANG
Publication year - 2017
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/jmcb.12373
Subject(s) - volatility (finance) , econometrics , economics , rational expectations , business cycle , vector autoregression , macro , information asymmetry , computer science , microeconomics , macroeconomics , programming language
The paper proposes endogenous information choice as a channel through which uncertainty affects price dynamics. I consider a rational inattention model with volatility uncertainty and endogenous information processing capability. According to the model, firms' learning and optimal attention exhibits inertia and asymmetry in response to volatility changes. Firms choose to process more information when uncertainty rises, especially about aggregate conditions, and their pricing behavior changes accordingly. Using a Markov‐switching factor‐augmented vector autoregression (MS‐FAVAR), the paper also documents a significant positive correlation between volatility and firms' responsiveness to macro‐ and microlevel shocks, consistent with model predictions.