Essays on Unawareness and Its Applications

What happens if a decision maker does not have the right information, and she does not know that she does not have this information? This type of incomplete information, formally called unawareness, is drawing more and more attention, especially in the literature on bounded rationality and behavioral economics. It is hard to deny that many individuals, such as consumers, investors, patients, workers and so on, can be unaware of information potentially important to them. Although current standard frameworks rely on full awareness, understanding unawareness is potentially relevant in many fields of economics. The theme of my dissertation research is to analyze unawareness in theory and in application, and to establish the link between this concept and standard frameworks. The dissertation is composed of four chapters. I first modify a classic example to demonstrate the difference between unawareness and imperfect information (impreciseness); then revise standard frameworks to accommodate unawareness; then apply unawareness in a general economic theory on agreement and no trade; finally study an important stock market regulation on information disclosure and show that unawareness has specific implication and it increases the explanation power of current theory on some empirical findings. I begin with the last chapter, which is also my job market paper. It studies a regulation implemented by the Security and Exchange Commission in 2000, called Regulation Fair Disclosure. The regulation requires that an issuer must make relevant information disclosed to any investor available to the general public in a fair manner. Focusing on firms that are likely to be affected by the regulation, I propose a model that characterizes the behavior of two types of investors – one professional investor and many small investors – in the regimes before and after the regulation, i.e., under selective disclosure and fair disclosure. In particular I allow both types of investors to be aware of relevant information symmetrically or asymmetrically. With symmetric awareness, fair disclosure induces both a low cost of capital and a low cost of information, therefore making the market efficient. Also, the professional investor collects an equal level of information under fair disclosure and under selective disclosure. However when small investors are not fully aware, fair disclosure still induces a low cost of capital but may induce a high cost of information. The professional investor may deliberately collect less information under fair disclosure than under selective disclosure. The asymmetric awareness assumption also produces predictions which match the empir-