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Convergence in Misspecified Learning Models with Endogenous ActionsAbstract:

We establish convergence of beliefs and actions in a class of one-dimensional learning settings in which the agent's model is misspecified, she chooses actions endogenously, and the actions affect how she misinterprets information. The crucial assumptions of our model are that the state and action spaces are continuous, the state has a unidirectional effect on output, and the prior and noise are normal. These assumptions imply that the agent's posterior admits a one-dimensional summary statistic, allowing us to apply tools from stochastic approximation theory to establish convergence. Applications of our framework include learning by a person who has an incorrect model of a technology she uses, is subject to confirmatory bias, conservatism, or base-rate neglect, or is overconfident about herself, learning by a representative agent who misunderstands macroeconomic outcomes, as well as learning by a firm that has an incorrect parametric model of demand.

Joint with Paul Heidhues and Philipp Strack. Updated December 2018.

An Attention-Based Theory of Mental AccountingAbstract:

We analyze how an agent with limited attention optimally attends to and responds to taste, price, income, and other shocks in basic consumption decisions. We identify several ways in which the agent can be interpreted to engage in mental accounting, and make additional predictions. When allocating consumption among goods with different degrees of substitutability, the agent may create budgets for the more substitutable consumption categories. If the goods are complements, in contrast, the agent -- consistent with naive diversification -- may choose a fixed, unconsidered mix of products. When managing her consumption from and transfers between an investment account and a checking account, the later of which she has an incentive to balance, the agent's marginal propensity to consume (MPC) out of shocks to the checking account is often greater than her MPC out of shocks to the investment account. Furthermore, to reduce the attention she must pay to her budgeting, the agent prefers to reduce spending risk, making her more averse to risk in the checking account than to risk in the investment account. As a result, she may optimally switch to a cheaper substitute product (such as a lower-grade gasoline) when a random price increase occurs.

Joint with Filip Matějka. Updated June 2018.

Browsing versus Studying: A Pro-Market Case for RegulationAbstract:

We identify a novel competition-policy-based argument for regulating the secondary features of complex or complexly priced products when consumers have limited attention. In our basic market models, each firm chooses two price components, a headline price and an additional price, and a consumer can either fully understand the offer of one firm (studying), or look at only the headline prices of two firms (browsing). Regulations capping the additional price or standardizing conditions under which the additional price can be charged lower prices and increase consumer welfare in a variety of environments. The core mechanism is simple: because consumers do not need to worry about regulated features, they can devote more attention to browsing, enhancing competition. Extending our model to multiple markets, we show that the benefits of regulating one market may manifest themselves in other markets, and that in order to have a non-trivial pro-competitive effect, the regulations in question must be sufficiently broad in scope. As an auxiliary positive prediction, we show that because low-value consumers are often more likely to study than high-value consumers, the average price consumers pay can be increasing in the share of low-value consumers. This prediction helps explain why a number of essential products are more expensive in lower-income neighborhoods.

Joint with Paul Heidhues and Johannes Johnen. Updated November 2018. Nice summaries in the Financial Times (subscription required) and the Independent.

Financial Choice and Financial InformationAbstract:

We analyze the implications of increases in the selection of, and information about, derivative financial products in a model in which investors neglect informational differences between themselves and issuers. We assume that investors receive information that is noisy and inferior to issuers' information, and that issuers can select the set of underlying assets when designing a security. In contrast to the received wisdom that diversification is helpful, we show that when custom-designed diversification across a large number of underlying assets is possible, then expected utility approaches negative infinity. Even beyond this limiting case, any expansion in choice induced by either an increase in the maximum number of assets underlying a security, or an increase in the number of assets from which the underlying can be selected, Pareto-lowers welfare. Furthermore, under reasonable conditions an improvement in investor information Pareto-lowers welfare by giving investors the false impression that they can spot good deals. An increase in competition between issuers does not increase welfare, and even increases investors' incentive to acquire welfare-reducing information. Restricting the set of underlying assets the issuer can use -- a kind of standardization -- raises welfare, and once this policy is adopted, increasing investor information becomes beneficial.

Joint with Péter Kondor. Updated May 2017.