Rational Inattention-driven dispersion with volatility shocks
Documento de Trabajo IE-PUC, N°530, 2019
Abstract: This paper studies price-setting decisions under Rational Inattention. Prices are set by tracking an unobserved target whose distribution is also unknown. The distribution of the target can change over time depending on persistent and unanticipated volatility shocks that hit the economy. Information acquisition is dynamic and fully exible since, given information acquired in the past, business owners choose the amount of information they collect as well as how they want to learn about both the outcome and its distribution. We show that by allowing for imperfect information to be the unique source of rigidity, the model can simultaneously reconcile several stylized facts in the microeconomic evidence on price setting, both at the cross-sectional and time series levels. Dynamic imperfect information endogenously generates persistence in beliefs, which is crucial in replicating
the dynamic empirical behavior of prices.
Keywords: Rational Inattention, Dynamic Information, Price Dispersion, Frequency
JEL Classification: E31, E32, D82, D83.