Information Costs and Sequential Information Sampling

Information Costs and Sequential Information Sampling

By Benjamin Hébert, Michael Woodford
November 14,2018Working Paper No. 3751

Revise and Resubmit, Econometrica

We propose a new approach to modeling the cost of information structures in rational inattention problems: the “neighborhood-based” cost functions. These cost functions have two properties that we view as desirable: they summarize the results of a sequential evidence accumulation problem, and they capture notions of “perceptual distance.” The first of these properties is connected to an extensive literature in psychology and neuroscience, and the second ensures that neighborhood-based cost functions, 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: security design, global games, modeling perceptual judgments, and linear-quadratic-Gaussian settings.