Limited attention and the allocation of effort in securities trading

Abstract The influence of limited attention on decision making has been analyzed in a variety of economic and psychological settings, but its impact on financial markets is not well understood. In this paper, we test whether the limited attention of human market makers influences trading in securities markets. We conduct pooled time-series and cross-sectional tests on individual NYSE specialist portfolios and find that transaction costs increase with the total trading activity of other stocks handled by the same specialist. The results indicate that specialists face significant processing limits and that they allocate effort toward their most active stocks during periods of increased trading activity. Concurrently, specialists reduce their attention to the other stocks in their portfolio, resulting in less frequent price improvement and increased transaction costs. Our evidence suggests that limited attention, and the resulting allocation of effort across stocks, have a significant impact on liquidity provision in securities markets. JEL classification: G10, G14, D23, J2

Limited attention and the allocation of effort in securities trading

Abstract The influence of limited attention on decision making has been analyzed in a variety of economic and psychological settings, but its impact on financial markets is not well understood. In this paper, we test whether the limited attention of human market makers influences trading in securities markets. We conduct pooled time-series and cross-sectional tests on individual NYSE specialist portfolios and find that transaction costs increase with the total trading activity of other stocks handled by the same specialist. The results indicate that specialists face significant processing limits and that they allocate effort toward their most active stocks during periods of increased trading activity. Concurrently, specialists reduce their attention to the other stocks in their portfolio, resulting in less frequent price improvement and increased transaction costs. Our evidence suggests that limited attention, and the resulting allocation of effort across stocks, have a significant impact on liquidity provision in securities markets. JEL classification: G10, G14, D23, J2