Framing Effects in Group Investment Decision Making
|School||Southwestern University of Finance and Economics|
|Keywords||framing effects group decision group polarization stock investment risky decision|
A "framing effect" is usually said to occur when equivalent descriptions of a decision problem lead to systematically different decisions. Specifically, people’s choices when faced with consequentially identical decision problems framed positively (in terms of gains) versus negatively (in terms of losses) are often contradictory. The "Asian disease problem" described by Tversky and Kahneman is a classic example of the framing effect. The Asian disease problem introduced by Tversky and Kahneman demonstrated behavior in contradiction to the invariance axiom of EU theory. In the Asian disease problem, one group of subjects choose between two programmes designed to combat a disease that is expected to kill 600 people. If one programme is adopted, there is one-third probability that 600 people will be saved and a two-thirds probability that no people will be saved. Another group of subjects choose between the programmes described in terms of lives lost. If one programme is adopted,400 people will die, and if the other programme is adopted, there is one-third probability that nobody will die and two-thirds probability that 600 people will die. When alternative outcomes were phrased positively in terms of lives saved, subjects preferred the certain option, When outcomes were phrased negatively in term of lives lost. The risky option was preferred. Although the same objective data were given in the two versions, framing caused preferences reversal that was explained in terms of the prospect theory:Positive framing of problems emphasizes the benefits while negative framing emphasizes risks. Whenever contemplating benefits, decision makers are prone to minimize risks (exhibiting "risk-aversion") whereas when contemplating loses decision makers are prone to take risks (demonstrating "risk-seeking").In the past 30 years, hundreds of empirical studies have been conducted to demonstrate and investigate the framing effect in many different contexts. Similarly, many theories have been developed to explain human behavior based on assessments of gains and losses. Framing has been a major topic of research in the psychology of judgment and decision making and is widely viewed as carrying significant implications for the "Rationality Debate" From the perspective of traditional economics and financial management, people are generally assumed to be rational and to make decisions based on their own ultimate benefit. However, numerous studies have found many anomalies violate the assumption of rationality, such as a small company, January, and weekend and holiday effects which indicate that people tend to make decisions that are more irrational in character than would be expected on the basis of classical economic perspectives.Multiple theories have been devised to explain the framing effect. These are broadly divided into formal, cognitive and motivational theories. Prospect Theory, the most well-known formal theory, explains the framing effect in terms of the value function for goods perceived as gains and losses from a reference point Whether an outcome is perceived as a gain or a loss depends upon the individuals reference point, which is usually taken to the "status quo" asset level at the time of the choice. The value function yields the preference value assigned to outcomes, and is concave for gains, convex for losses, and steeper for losses than for gains. This functional form implies that decision makers are more sensitive to losses than to gains and exhibit diminishing marginal sensitivity to both. Therefore, people will tend to opt for a sure alternative perceived as a gain rather than for a risky alternative of equal expected value, while the converse will hold true for perceived losses. Cognitive theories are designed to determine the cognitive processing involved in weighting gains and losses. For example, the fuzzy-trace theory proposes that the framing effect is the result of superficial and simplified processing of information. To evaluate this theory, researchers suggested and tested mechanisms by which decision makers might simplify framing problems by reasoning in qualitative patterns rather than in probabilistic and numerical patterns. The findings suggest that participants follow the path of greatest simplicity by using simplification mechanisms to reduce cognitive demands. More comprehensively, cognitive cost-benefit tradeoff theory defines choice as a result of a compromise between the desire to make a correct decision and the desire to minimize effort. This theory holds that individuals initially peruse the available alternatives to determine if they can make a good decision and expend minimal cognitive effort. They only commit to a more complicated cognitive effort if they cannot fulfill their desire to arrive at a good decision by embracing a simpler alternative. Although this is an appealing explanation of the framing effect, this model ignores affective processes that should play an important role in determining what constitutes a good decision. Motivational theories explain the framing effect as a consequence of hedonic forces, such as the fears and wishes of an individual. According to these models, decision makers assign stronger value to feelings of displeasure than to feelings of pleasure, and this disparity increases proportionately with the amount of gain or loss involved in a decision. In other words, like Prospect Theory’s assumption that losses loom larger than equivalent gains, motivational models are based on the claim that the emotions evoked by the losses generally are greater than those evoked by gains. In decision problems that require choices, Kahneman and Tversky define a decision frame as referring to the decision maker’s conception of acts, outcomes, and contingencies associated with a particular choice.Over the past two decades, the effect of framing on human judgment and decision-making has been documented in various domains proposed to differentiate between three types of framing effects that are distinguishable in terms of their operational definitions, and their likely underlying processes.The three types are:risky choice framing; attribute framing; and goal framing. Risky choice framing relates to problems such as the "Asian disease". The second type, attribute framing, relates to situations in which an object or an event is evaluated more favorably when presented in a positive frame relative to presenting the very same object or Heart tag key ring event in a negative frame. Levin and Gaeth (1988) exemplified this type of framing by showing that participants evaluated the quality of a ground beef product presented as "75 percent lean" (positive frame) as higher than when presented with the same product described as "25 percent fat" (negative frame). The third type, goal framing, describes the consequences of an action given in a positive frame that emphasizes gain following an action or in a negative frame that focuses attention on Somerset basic hoop earrings a negative consequence (loss) following inaction. Typically, people are more convinced to take an action when presented with the negative consequences of not taking it relative to the positive consequences of taking it. Thus, goal framing describes situations in which a negative frame better promotes a certain goal and has greater persuasive impact than positive framing of the same situation. Several studies exemplified this effect in which people are willing to waive the same objective value when it was presented as a gain but are unwilling to waive it when it is presented as a loss. The effect described by the goal framing can be explained by the prospect theory, The subjective value of any given objective information is more extreme for losses than gains ("losses loom larger than gains"). As a result, a message framed negatively, highlighting the negative impact of not taking an action, would be more effective than the same objective message emphasizing the positive benefits of taking it. It would seem that goal framing could be used by retailers who wish to promote specific products over others using discounts to elevate the perceived attractiveness of certain products. Accordingly, retailers could use negative framing emphasizing the losses associated with not purchasing the promoted products rather than using the positive framing emphasizing the gains associated with purchasing them. This possibility actually contradicts the common practice of retailers that typically promote products using positive (gain/save) terms. One specific group of products that retailers wish to promote extensively is private brands.Framing effects occur when the precise way in which a problem or choice is presented, i.e., its frame, affects the decision maker’s perception of a problem or choice, and ultimately the decision maker’s preference. For example, due to framing effects, investors presented with gain situations were likely to make cautious or conservative decisions, i.e., a risk-averse tendency, whereas those who faced loss situations were likely to make risky decisions, i.e., a risk-seeking tendency. Group decision making on investments exhibits the same framing effects as individual decision making, and that framing effects are more important in group than in individual decision making. Group polarization may lead decision-making groups to adopt positions that are increasingly extreme and, therefore, increasingly risky. In conclusion then, framing effects in investment decisions are more prominent in group decision-making situations. In this study, we carried on one experiments to document the existence of framing effects in individual investors and group investors’stock investment decisions. In experiment 1, a 2 (positive vs negative risky choice framing)×2(high vs low payoff-size) between-subject design was adopted.A hypothetical stock investment scenario which is designed according to the "Asian Disease problem" was used and 120 participants were assigned randomly to conduct the four experimental conditions.