Limited Attention and the Allocation of Effort in Securities Trading

Abstract

While limited attention has been analyzed in a variety of economic and psychological settings, its impact on financial markets is not well understood. In this paper, we examine individual NYSE specialist portfolios and test whether liquidity provision is affected as specialists allocate their attention across stocks. Our results indicate that specialists allocate effort toward their most active stocks during periods of increased activity, resulting in less frequent price improvement and increased transaction costs for their remaining assigned stocks. Thus, the allocation of effort due to limited attention has a significant impact on liquidity provision in securities markets. Copyright (c) 2008 The American Finance Association.

Portfolio choice, attention allocation, and price comovement

“…The evidence presented in Corwin and Coughenour [4] provides strong support for the implications of the model. They measure the attention allocated by a NYSE specialist to each asset, constructing a proxy for attention allocation based on the number of transactions and the absolute return during a given trading period.…”

“…For tractability reasons, they are assumed to process information about prices for free. 4 Investors choose an optimal private signal to reduce the uncertainty about asset payoffs subject to the following information processing…”

Behavioural Finance: A Review and Synthesis

“…What is the effect of cognitive biases of market makers on price formation? A start on the study of this subject is the paper by Corwin and Coughenour (2005) who argue that limited attention influences transaction costs. Specifically, it is shown that specialist attention gets diverted to the most active stocks in their portfolio, thus raising transaction costs and leading to less frequent price movements in the less active ones.…”

The Impact of Attention to News about Tax Changes on the Stock Market

“…Moreover, Drake, Roulstone and Thornock (2012) claim that an abnormal Google search volume is positively associated with press coverage among other things. There is large body of studies supporting this (Ryan and Taffler (2004), Hirshleifer et al, 2004, Della Vigna and Pollett, 2003, Corwin and Coughenour, 2005. According to the studies, we hypothesise that not only changes in taxes but also the attention of the news to changes in tax policy have an impact on stock prices.…”