Inattention to States and Characteristics

TL;DR

This paper develops a rational inattention model that yields a unique, weighted multinomial logit choice probability by incorporating costly information acquisition about choices and states, using a novel two-level optimization approach.

Contribution

It introduces a new model combining rational inattention with a Schrödinger bridge framework to analyze choice behavior under costly information acquisition.

Findings

Produces a unique choice probability distribution.

Reformulates the problem as a two-level optimization.

Provides a tractable solution via Schrödinger bridge methods.

Abstract

We introduce a rational inattention model which produces a unique, interior, weighted multinomial logit conditional choice probability for an agent who acquires costly information about the hedonic characteristics (e.g. whether an insurance contract has high coverage) of their choices and about their payoff-relevant states (e.g. their risk of incurring a loss). As usual, the objective is to choose a joint distribution subject to one marginal constraint (``Bayes plausibility''). We approach the problem by re-writing it in terms of an inner problem of maximizing over \textit{two} constraints and an outer problem of choosing the ``optimal constraint.'' The inner problem is a Schr\"odinger bridge problem. The outer problem is strictly concave.