Too many irons in the fire: The impact of limited institutional attention on market microstructure and efficiency

Abstract

This paper presents an in-depth exploration, both empirically and theoretically, of how institutional attention impacts market microstructure. Our innovative theoretical model incorporates an information processing constraint into the dynamic strategic trading framework. The model predicts a trade-off where increased institutional attention enhances price informativeness at the expense of market liquidity, and suggests that the unmonetized portion of institutional investors’ information advantage significantly influences the effect of public information about an asset’s fundamental value on market microstructure. Additionally, our findings are substantiated through rigorous empirical analysis.