Limited Attention

Investor attention is a limited resource. This chapter discusses the literature on investor limited attention and its effects on capital markets. Theoretical and empirical studies find that when some investors are inattentive, the immediate market reaction to news is incomplete and the price exhibits a post-announcement drift. The underreaction is stronger when investor attention is distracted by competing stimuli, when the information is less salient or harder to process, and when investors are less sophisticated. While retail investors suffer more from limited attention, the effects of limited attention are also significant for sophisticated market participants, such as financial analysts, institutional investors, market makers, and financial data providers. Firms incorporate investor limited attention by choosing disclosure timing and format to highlight good news and reduce attention to unfavorable information. Collectively, the reviewed studies indicate that investor limited attention has important and far-reaching effects on capital markets