Attention Allocation Over the Business Cycle

Abstract

The invisibility of information precludes a direct test of attention allocation theories. To surmount this obstacle, we develop a model that uses an observable variable { the state of the business cycle { to predict attention allocation. Attention allocation, in turn, predicts aggregate investment patterns. Because the theory begins and ends with observable variables, it becomes testable. We apply our theory to a large information- based industry, actively managed equity mutual funds, and study its investment choices and returns. Consistent with the theory, which predicts cyclical changes in attention allocation, we ¯nd that in recessions, funds' portfolios (1) covary more with aggregate payo®-relevant information, (2) exhibit more cross-sectional dispersion, and (3) gener- ate higher returns. The results suggest that some, but not all, fund managers process information in a value-maximizing way for their clients and that these skilled managers outperform others.