Neighborhood-Based Information Costs
Benjamin Hébert, Michael Woodford
American Economic Review · 2021 · Volume 111 · Issue 10
Abstract
We derive a new cost of information in rational inattention problems, the neighborhood-based cost functions, starting from the observation that many settings involve exogenous states with a topological structure. These cost functions are uniformly posterior separable and capture notions of perceptual distance. This second property ensures that neighborhood-based costs, unlike mutual information, make accurate predictions about behavior in perceptual experiments. We compare the implications of our neighborhood-based cost functions with those of the mutual information in a series of applications: perceptual judgments, the general environment of binary choice, regime-change games, and linear-quadratic-Gaussian settings.
Keywords
Game Theory and Bargaining Theory: General, Consumer Economics: Theory, Asymmetric and Private Information, Mechanism Design, Search, Learning, Information and Knowledge, Communication, Belief, Unawareness, Micro-Based Behavioral Economics: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
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