Knowledge that Transforms

We study the long-term impact of limited attention on belief formation. To this end, we propose a rank-dependent model of inattentive learning, building on principles from the behavioral science literature. We provide explicit formulas for the distorted limiting beliefs and the asymptotic variance that characterizes the speed of learning. In our model, agents who pay excessive attention to extreme observations end up learning a distorted version of the true data-generating process which puts too much weight on the tails of the distribution. We show how the implications of our model can be linked to empirically documented phenomena such as skewness-seeking behavior and the coexistence of over- and underreaction to incoming information depending on the context. Limited attention can thus have long-lasting impacts on the beliefs agents form.

Using the adoption of Zombie Property Laws (ZL) across several US states, we show that requiring lenders to maintain properties in the foreclosure process affects mortgage lending decisions and standards. Difference-in-differences estimations using a state border design show that ZL incentivizes lenders to screen mortgage applications more carefully: they deny more applications and impose higher interest rates on originated loans, especially risky loans. In turn, these loans exhibit higher ex post performance. ZL also affects lender behavior after borrowers become distressed, causing them to strategically keep delinquent mortgages alive. Our findings inform the debate on policy responses to foreclosure crises.

I analyze the effect of non-compete agreements (NCAs) on the allocation of inventors across product markets. NCAs constrain the within-industry employment choice set of inventors. In a staggered difference-in-differences, I show causal effects that two in hundred inventors per year (increase of 42 percent) respond to more enforceable NCAs by moving to more distant product markets. Across-industry mobility is largest for inventors likely bound by NCAs. Within-industry mobility on the other hand is reduced. Reallocated inventors are subsequently less productive and there is a lower quality match between inventors and their new employers. I highlight how product market choice set constraints can have detrimental effects through reallocation of human capital to more distant product markets.

We survey portfolio companies of a large asset owner to explore the evolving landscape of nature risks. Nearly half of all companies (48 percent) view nature risks as financially material, and 43 percent of those perceive nature-related physical risks, and 27 percent transition risks, as having financial effects already today. Three-quarters of companies experiencing nature-related investor engagement view these interactions as value-generating. Nonetheless, according to the respondents, investor attention remains limited in key respects: while 40 percent report that investors consider nature risks, fewer than 25 percent believe investors assess how these risks affect cashflows or costs of capital. Half of the respondents believe investors will prioritize climate over nature; however, many think both topics are so intertwined that they cannot be separated. Our findings underscore the growing recognition of nature risks as financially relevant, while also pointing to challenges and opportunities for their integration into financial analysis and investor engagement.

We study the impact of financial advice on retirement savings. We document that advisors help clients to prepare for retirement by inducing them to take advantage of tax incentives offered on retirement accounts. Advisors particularly promote retirement funds as compared to savings accounts. After-tax returns of advisor-induced retirement fund investments exceed returns of plausible alternative investments. We find no indication that advisor-induced contributions to retirement accounts lead to negative side effects, such as reductions in other savings or liquidity constraints. Hence, we provide evidence of a bright side of financial advice. Furthermore, investments in retirement funds increase bank profits, pointing toward a win–win situation with rent-sharing between the bank and its clients. However, advisors do not in particular target clients that are at a higher risk of under-saving for retirement, such as female clients, clients with lower wealth, and less-educated clients.

We conduct a randomized experiment involving 7,063 late-paying clients of a large Colombian bank to compare the effects of text messages that leverage different behavioral motives on loan delinquency. Our results show that receiving a message decreases the likelihood of borrowers being late by 4 percent. The effects are more pronounced and persistent when messages leverage social norms. Using machine learning tools, we find that the effects are higher among borrowers with higher credit scores and unsecured loans. A second experiment shows that this type of message is ineffective in preventing on-time borrowers from falling into loan delinquency.

Privately informed about firm fundamentals, corporate insiders detect activism-motivated trades better than other traders. This article solves the model of this novel form of insider trading motivated by noninsider information and presents empirical evidence. Corporate insiders preserve their ownership (restraining from selling or buying more) before activist interventions go public to benefit from price appreciation and to defend their private benefits of control. Surveillance technology facilitates response to predisclosure activist trading, especially when positive information about firm fundamentals is absent, supporting the mechanism that insiders attribute order flows to activist interest when speculation on fundamentals can be ruled out.

Should banks be transparent during a bail-in? Banks suffering losses may bail-in creditors to optimally allocate resources between early and late withdrawers. However, if losses are private information, then bail-ins may signal asset quality. In the absence of signaling, banks can sell assets at a pooled price, effectively insuring creditors against asset risks. However, when bail-ins signal quality, banks may delay bail-ins and sell assets at higher prices than otherwise, but this incentive can trigger inefficient bank runs. To prevent such runs, banks should choose to be either fully transparent or entirely opaque, ensuring asset quality is not private information.

We show that the transmission of a monetary policy tightening varies in the cross-section of banks when central bank reserves are abundant. Specifically, the net worth of reserve-rich banks may display a boost when the interest rate paid on reserves increases strongly. Focusing on the European Central Bank’s 2022 rate hiking cycle, we show that reserve-rich banks’ credit supply is less sensitive to the monetary policy tightening compared to other banks. The effect varies in the cross-section of both banks and firms. The results are binding at the firm level, indicating the presence of real effects.

Cyber risk exposes banks to operational disruptions that can trigger runs. A bank chooses its cybersecurity by trading off protection against attacks with remaining resilient if an attack succeeds. Cybersecurity functions as a risk-management decision: it reduces the bank’s exposure to adverse outcomes but entails lower balance-sheet returns. Equilibrium cybersecurity depends on whether failure is driven by insolvency or illiquidity. When failure is insolvency-driven, bank and creditor actions reinforce one another: greater cybersecurity leads to a higher debt burden, which strengthens incentives for protection. When failure is illiquidity-driven, additional cybersecurity lowers the debt burden, eliminating the bank’s private risk–return trade-off. Socially optimal cybersecurity differs from the private choice, and corrective instruments must target either the protection or resilience margins. We extend the model to a system-wide environment in which cybersecurity is a public good, highlighting free-riding and the need for targeted regulation.