Irrational inattention

with Ciril Bosch-Rosa, Bernhard Kassner.

Data analysis stage.

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Rational inattention and overconfidence influence the way information is processed, leading individuals to underreact to new information. Yet, even if their effects go in the same direction, they are fundamentally different. While rational inattention characterizes an optimal behavior, overprecision is a bias. In this paper, we develop a belief formation model where overprecise agents optimally decide how much attention to pay to information. This allows us to disentangle the effect of overprecision from rational inattention when the costs to process information change. The results show that overprecision distorts the optimization problem of rationally inattentive agents, making them more sensitive to changes in the marginal cost of information and less likely to update in response to new information. Such an effect adds a new layer of heterogeneity in the way that individuals react to changes in information processing costs. We support the predictions of our model using a randomized information provision experiment on a representative sample of the German population and show that overprecise.