Chapter 22
Framing Bias
Prepared By : DR. Wael Shams EL-Din
Cognitive Biases
Cognitive Biases
Information Processing Errors Belief Perseverance errors
1. Cognitive dissonance Bias
1. Framing Bias
2. Illusion of Control Bias
2. Anchoring Bias 3. Self attribution Bias
3. Mental Accounting Bias 4. Conservatism Bias
5. Overconfidence Bias
4. Availability Bias 6. Confirmation Bias
FAMA 7. Ambiguity aversion Bias
8. Representativeness Bias
9. Hindsight Bias
10. Recency Bias
CISCO CAR HR
Information Processing
Errors
Framing Anchoring
Bias Bias
Mental Availability
Accounting
Bias Bias
Framing Bias
General Description
❑ Framing bias is the tendency of decision makers to respond to various
situations differently based on the context in which a choice is
presented (framed). In real life, people usually benefit from some
flexibility in determining how to address the problems they face.
Which Line Is Longer?
General Description
❑ People are subject to visual illusion, which leads them to insist that the
line on the bottom is longer than the upper line. But after putting The
vertical marks as a guide, the two lines are equal. So removing framing
effect, it becomes clear for us that the line on the top and the line on the
bottom are equal in length.
❑ Another Example
one view can be formulated in TWO WAYS:
1. 25% of patients will be saved if they are provided with medicine XYZ
2. 75% of patients will die without medicine XYZ
Most People in the first case will adopt a gain frame, which generally leads to risk-
averse behavior. In the second case, most people will adopt a loss frame and
thereby become engage to risk seeking behavior.
Implications for Investors
❑ An investor’s willingness to accept risk can be influenced by how
questions are framed either positively or negatively. The same optimism
or pessimism in framing can impact investment decision.
Example
❑ Suppose that Mrs. Smith chooses to invest in either Portfolio (A) or
Portfolio(B). suppose that Portfolios (A) and(B) are identical in every respect.
Mrs. Smith have informed that Portfolio (A) will offer her a 70% chance of
attaining her financial goals, whereas Portfolio (B) offers a 30% chance of
NOT attaining her financial goals. If Mrs. Smith is like most people, she will
choose Portfolio (A), because its performance projections were more
attractively framed.
Framing & Four
Investor Mistakes
Investment Mistake No.1 & Mitigation
Investment Mistake “Risk” Mitigation
❑ Framing bias can cause investors ❑ Risk tolerance questionnaire
to respond wrongly to questions is very critical in assessing
about risk tolerance that are either client goals and selecting
too conservative or too aggressive. appropriate investments, so
Advisors, need to be familiar
with question wording.
❑ For example, when questions are
worded in the “Gain” frame, a ❑ Advisor need to understand
risk-averse response is more likely. and remain alert for biases
When questions are worded in the that can be raised when
“Loss” frame, risk-seeking questions are formulated in
behavior is the likely response certain ways.
❑ Advisor have to make a clear
communication with investor
to ensures the success of the
advisory relationship.
Investment Mistake No.2 & Mitigation
Asset allocation Mitigation
❑ The optimistic or pessimistic ❑ We have observed the large
manner in which an investment or influence that positive and
asset allocation recommendation is negative framing can do. So The
framed can influence investor’s lesson learned for practitioners is
decision. to present facts and choices to
❑ Questions that written in clients as neutrally and uniformly
Optimistic words will probably as possible.
create positive responses, ❑ This will reduces the probability
compared with pessimistic of a biased client response and
phrases as alternatives. should help you to assist your
❑ Framing context is uncorrelated investors to achieve his financial
and therefore shouldn’t impact goals.
investors’ judgments …. but, they
do.
Investment Mistake No.3 & Mitigation
Narrow Framing Mitigation
❑ Investors that exposed to narrow ❑ Advisors should encourage
framing may become worried clients to look to the big picture
when short-term price fluctuated i.e. overall wealth accumulation
in an single stock or industry, or and long-term financial goals.
they may favor certain asset
classes to others.
❑ Clients should work on building
balanced asset allocations and
❑ The risk here is that by focusing focus on ensuring that those
only on short-term market allocations are helping them to
fluctuations, excessive trading meet their financial goals.
may be the result. This trading
behavior has proven to be less than
optimal for investors.
Investment Mistake No.4 & Mitigation
Loss Aversion Mitigation
❑ Framing and loss aversion can ❑ Advisors should encourage
work together to describe extreme clients to separate from their
risk aversion. ongoing decision making any
references to gains or losses
earned in a previous period.
❑ Investors who feel that they’ve
been doing poorly will seek out ❑ Advisors should also try to ask
risks, while those happy with their questions that are less likely to
recent returns tend to play it safe. cause biased answers.
❑ Finally, education, diversification
and proper portfolio management
can help to neutralize these
biases.
Framing Bias Mini-Test 1
Question 1
❑ Suppose that you have the opportunity to invest in a fund called Micro
Trend. Over the past 10 years, Micro Trend has made an average annual
return of 6% , with a standard deviation of 10%. So if Micro Trend
continues to perform consistently, you can expect 2/3 of all returns to
fall between 4% and 16% .
How comfortable would you feel about investing in Micro Trend?
A. Comfortable.
B. Somewhat comfortable.
C. Uncomfortable
Framing Bias Mini-Test 1
Question 2
Suppose that you have the opportunity to invest in a fund called Micro
Trend. Over the past 10 years, Micro Trend has had an average annual
return of 6%, with a standard deviation of 10% . So if Micro Trend
continues to perform consistently, you can expect 95% of all returns to
fall between 14% and 26%
How comfortable would you feel about investing in Micro Trend?
A. Comfortable.
B. Somewhat comfortable.
C. Uncomfortable.
Test Results Analysis
Mini-Test 1
❑ People who answer the second question differently from the first are
likely subject to framing bias.
❑ If you are a practitioner and your client answers in this fashion, then
you should remain aware of the manner in which you present
information to the client because subjective details can have a dramatic
impact.
❑ Typically, investors inclined to framing bias choose the riskier strategy
in Question 2.
Framing Bias Mini-Test 2
Question 1
❑ Suppose you are preparing for retirement. You need $50,000 annually to
live comfortably; but you could take care of basic needs at about $40,000
and could even survive on a minimum of $30,000 if necessary. Further
assume that there is no inflation. Now, imagine that you are choosing
between two hypothetical investment options.
❑ Option 1: Guarantees you an income of $40,000 per year—offering you
a chance at a risk-free lifestyle.
❑ Option 2 : Offers you a 50% chance at $50,000 and a 50% chance at
receiving $30,000 each year.
Which Option Would You Choose?
A. Option 1.
B. Option 2.
Framing Bias Mini-Test 2
Question 2
❑ Suppose you are preparing for retirement. You need $50,000 to live
comfortably, but could take care of basic needs at about $40,000, and
could even survive on a minimum of $30,000 if necessary. Further
assume that there is no inflation. Now, imagine that you are choosing
between two hypothetical investment options.
❑ Option 1: guarantees you enough income to cover your needs, but it will
never provide you a comfortable lifestyle.
❑ Option 2: you have the opportunity for a better lifestyle. With a
probability of 50% you might be limited to your simple minimum
acceptable income. But, with a corresponding probability of 50%, you
would enjoy the comfortable lifestyle you desire and an income of
$50,000.
Which Option Would You Choose?
A. Option 1
B. Option 2
Test Results Analysis
Mini-Test 2
❑ This test can’t be interpreted too rigidly because lifestyle preferences
are not black and white. However, people subject to framing bias will
probably prefer an assured income in Question 1 and a riskier strategy
in Question 2. This is because Question 1 is framed in a relatively
positive fashion, focusing on the attribute “Safe” lifestyle offered from
the guarantee in Option 1.
❑ The framing in Question 2, however, is less positive; it reminds you that
neither investment option offers you a reliably agreeable standard of
living. When framing intersects with loss aversion, this type of response
pattern is especially likely to result.
Framing Bias in Brief
Item Explanation
What ❑ Answer the question differently depending on context
or way the question was asked ( framed)
Consequences ❑ Fail to properly asses risk
❑ Focus on short term price fluctuation which lead to
trading too frequently
❑ Can be related to loss aversion / risk aversion
depending on how information presented
❑ Very common with analysts when evaluating company
management performance
Mitigation ❑ You have to be really accurate for source of information
and the way you are presenting information as well.
Thank You
