Framing

"The term frame dependence means that the way people behave depends on the way that their decision
problems are framed."

Shefrin (2000)

Framing is a cognitive heuristic in which people tend to reach conclusions based on the 'framework'
within which a situation was presented.

[KaTv00] "The rational theory of choice assumes description invariance: equivalent formulations of a
choice problem should give rise to the same preference order (Arrow, 1982). Contrary to this
assumption, there is much evidence that variations in the framing of options (e.g., in terms of gains or
losses) yield systematically different preferences (Tversky and Kahneman, 1986)."

Framing

News is interpreted in a way that supports the trend

- Loss aversion

- regret

- mental accounting

framing:

investors indeed realize their gains more readily than their losses. And the winning investments investors
chose to sell continue to outperform the losers they hold on to in subsequent months.

Framing - with reliance on how information is presented, a judgment is made on the benefit of a choice

"Empirical studies show that decisions deviate from the predictions of expected utility theory and violate
their axiomatic foundations. Hence, many generalizations to non-expected utility theory have been
developped. But empirically they did not provide an improvement over the standard approach. In this
paper random errors are integrated in an expected utility framework. Such errors occur when agents
have limited information processing capacities. A performance criterion is provided to measure the
expected success of behavioral strategies. A special class of robust decision rules and its properties are
analyzed. It is argued that in case of bounded rationality the evolution will select heuristics from an open
class of decision rules due to performance differences."

Pasche
FRAMING

Framing refers to the observation that people’s decisions tend to be affected by the way in which the
choices are framed. One important case in which framing occurs is the following. Individuals may behave
risk averse in terms of potential gains but behave risk seeking in terms of potential losses.

Let’s consider two examples to illustrate this behavioral bias. The first one illustrates the concept of
framing visually, the second example provides an example that explains the concept in a financial
context.

VISUAL FRAMING EXAMPLE

To get the intuition behind framing, consider the figure below. Do you think the lines have the same
length? While both lines appear to be different in length, this is actually not the case. You can measure
the length of both lines. This is an optical illusion, but illustrates the concept of framing in an intuitive
way.

FINANCE FRAMING EXAMPLE

Next, we consider a financial example. Suppose we create following experiment. To some of the
participants, we propose the following coin toss. In the case of tails, the payoff is 50, and zero otherwise.
Alternatively, we give some participants a gift of 50, but they also have to participate in a coin toss that
imposes a loss of 50 when the coin toss comes up heads.

The way the above experiment is structured, you end up with zero in the case of heads, and 50 in the
case of tails. As such, the payoff is the same in both cases. Still, the first description ‘frames’ the coin toss
as a risky gain, while the second situation ‘frames’ the coin toss as a risky loss. The consequence will be
that most people will agree to the first gamble, but not to the second.
SUMMARY

We have discussed framing, a behavioral bias that causes people to accept or decline proposals
depending on the the way they are framed. Even though the payoff is the same, people will agree to
proposals framed as risky gains, but will decline the proposals described as risky losses.

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