Framing effect and financial decisions

What is the framing effect ?

The framing effect is a cognitive bias that describes how people’s decisions and choices are influenced by the way information is presented or “framed”. This bias suggests that the way a message or option is framed can significantly impact how individuals perceive the information and subsequently make decisions, even if the underlying content remains the same.

The framing effect is often observed in situations where the same information is presented in different ways, leading to different responses.

Here’s an example to illustrate the framing effect:

Imagine a medical treatment with two options:

Option A: There is a 70% chance of survival. Option B: There is a 30% chance of death.

Both options convey the same outcome: a 70% chance of success. However, people tend to view Option A more positively because the information is framed in terms of survival, even though the numerical value is the same. The framing of the information can influence individuals to choose the option that sounds more favorable or less risky.

Framing effect affects our daily decisions

The framing effect can be observed in various contexts, including marketing, politics, healthcare, and decision-making in general. It highlights the psychological impact of how information is presented and how people respond to different framing techniques.

Academic background of the framing effect

The theoretical foundations of framing effects can be traced back to research conducted by Amos Tversky and Daniel Kahneman in 1981. During their social experiment, they explored how different phrasing could affect participants’ responses to a choice in a hypothetical life and death situation.

Later on, in their seminal paper The framing of decisions and the psychology of choice, they introduced the concept of framing effects and demonstrated their impact on decision-making, using hypothetical scenarios and experiments. In 1998, Levin, Schneider and Gaeth proposed a typology of framing effects, identifying four different types of frames that can influence decision-making in their paper named All frames are not created equal: A typology and critical analysis of framing effects.

The different types of framing effect

  • Positive vs. Negative Framing: As shown in the medical treatment example, positive framing emphasizes gains and benefits, while negative framing emphasizes losses and risks.
  • Gain-Loss Framing: This type of framing focuses on what can be gained or lost by choosing a particular option. People tend to be more risk-averse when choices are framed in terms of gains and more risk-seeking when choices are framed in terms of losses.
  • Attribute Framing: This involves emphasizing different attributes or qualities of an option to influence perception. For instance, highlighting the fat content of a food product can make it appear less healthy, even if the overall nutritional value is acceptable.
  • Temporal Framing: This involves presenting information in terms of time, such as short-term gains versus long-term gains, which can influence decision-making based on time preferences.

How to mitigate the framing effect?

  • Awareness: Being aware of the framing effect can help individuals make more objective decisions by consciously considering the underlying content rather than being swayed solely by how it’s presented.
  • Critical Thinking: Practice critical thinking when making decisions. Analyze the information presented from different angles to understand the implications of each option.
  • Consider Multiple Frames: When presented with a choice, try to reframe the information in different ways to gain a more comprehensive understanding of the decision’s implications.
  • Focus on Core Content: Try to focus on the core content or information presented rather than getting caught up in the way it’s presented.

Recognizing and understanding the framing effect can enable individuals to make more informed and rational decisions by evaluating options based on their actual content rather than being overly influenced by the presentation style.