BEHAVIOURAL FINANCE

Research Paper on “ Effect of Framing on Investor Decision Making”

GROUP – 8

NAME SAP ID
Antara Jasrotia 80012100724
Roma Paryani 80012100161
Ritika Kanchi 80012100232
Shreya Kwatra 80012100099
Chandrama Datta 80012100308
 Effect of Framing on Investor Decision Making

Abstract

Twenty years of experimental and empirical research has demonstrated that markets are not as
efficient as perceived to be. Investors are not rational and risk preferences are stochastic. In
addition to this, prospect theory criticized the standard expected utility hypothesis used to describe
utility and investor performance preferences. This study examined investment scenarios with
individual investors indicating that the process of making investment decisions is based on the
behavioral economics theory which uses the fundamental aspects of the prospect theory. The study
tested two items: firstly framing which modifies the investment decision depending on the
perspective given to the problem and secondly loss aversion which refers to a scenario where
greater utility is lost when losing x amount of money than the utility that is gained when obtaining
the exact same amount. Several economics studies find evidence that individuals decrease their
preference for risky choices when they are responsible for other people’s outcomes. This research
uses One Way Anova to test whether there are differences in investment decisions. Our
experimental results show that responsibility affects risky decision-making preferences; when
individuals are responsible for a group's risky choice, they tend to be more cautious and have lower
risk preferences in both positive and negative framing. However, individuals who have no
responsibility within the group show a higher risk preference on negative framing rather than
positive framing, this finding in line with prospect theory.

Introduction

Investment has evolved in the present economic climate into a worldwide economic medium that
supports economic actors, particularly investors, when they need to make an investment. They
have the chance to make a bigger return than other financial instruments due to the fluctuation and
changes in stock values.

Management requires data and information as the basis of consideration in decision making. Such
information includes financial information, legal aspect information, environmental impact
analysis, and other information. When making decisions, an individual will arrange the
information around him as a consideration. Several decision-making alternatives and its impacts
also affect an individual's decision making.

Prospect Theory - It is a theory that criticizes the expected utility theory. It finds the deviation of
expected utility theory and concludes that the expected utility theory can not be accepted as a
descriptive model to explain the decision-making principle. Then an alternative model of South
East Asia Journal of Contemporary Business, was developed to identify individual risky decisions
making called the prospect theory. Prospect theory states that the outcomes are expressed as
positive or negative deviations (gains or losses) from a neutral reference point set at zero.
According to this theory a choice that is assured of no risk at all will be preferred over options that
still carry risks although the slight likelihood of risk. The tendency to choose such a riskless option
is called a certainty effect, which gives the risk aversion in the choice of profits and the risk taking
on the options that inevitably result in a loss.

Framing - Framing refers to the way a problem is posed for the decision maker. Framing posits
that how a concept is presented to individuals matters. If information is presented positively it is
received more easily than negatively stated information even if the messages have neutral effects.
The process by which people formulate decision problems for themselves is termed as mental
accounting. This matters because in prospect theory, utility is nonlinear. One important feature of
mental accounting is narrow framing, which is the tendency to treat individual gambles separately
from other portions of wealth.

Loss aversion - This describes a scenario where greater utility is lost when losing x amount of
money than the utility that is gained when obtaining the exact same amount. In the domain of
money the people value a loss roughly twice the same size of gain. This asymmetry in the valuation
is called loss aversion. If individuals are loss-averse they either will not participate in equity
markets or will allocate considerably less of their wealth to equities. If individuals are loss-averse
the potential pain from stock market declines outweighs the pleasure from gains even with a high
equity premium. As a result, loss-averse individuals choose to avoid any exposure to equity. Loss
aversion implies that individuals frame events as either gains or losses relative to a reference point.
In investments, this phenomenon is believed to manifest itself in what is known as the “disposition
effect”.

Money Illusion - An important theme of behavioral finance is frame dependence which holds that
differences in form may also be substantive. Money illusion posits that people have a tendency to
view their wealth and income in nominal dollar terms, rather than recognize their real value,
adjusted for inflation. Economists cite factors such as a lack of financial education and the price
stickiness seen in many goods and services as triggers of money illusion.

Review of Literature

Numerous studies have examined the effect of framing on investor decision making, and the results
are mixed. Some studies suggest that framing can influence investor behavior, while others
indicate that it has little or no impact.
One of the earliest studies on the topic was conducted by Tversky and Kahneman (1981), who
found that the way investment opportunities are presented can influence investors' decision
making. They found that people are more likely to take risks when the situation is framed
positively, such as when the potential gain is emphasized, and are more risk-averse when the
situation is framed negatively, such as when the potential loss is emphasized.

Another study by Barberis and Thaler (2003) examined the effect of framing on mutual fund
investors. They found that investors are more likely to invest in funds with high past returns when
those returns are presented in a positive light (e.g., "this fund has gained 20% over the past year"),
but are less likely to invest in those same funds when the returns are presented in a negative light
(e.g., "this fund has lost 80% of its value over the past year"). The study conducted by Weber, E.
U., & Johnson, E. J. (2009) provided an overview of research on the cognitive and affective
processes involved in decision-making. It discussed the role of framing in decision-making and
highlights the importance of being mindful of how information is presented.

Similarly, Hsee and Kunreuther (2000) found that framing can influence investors' willingness
to purchase insurance. They found that people are more likely to purchase insurance when the
benefits are framed positively (e.g., "you will receive $10,000 if your house is destroyed") than
when they are framed negatively (e.g., "you will lose $10,000 if your house is destroyed").

However, other studies have found little or no effect of framing on investor decision making. For
example, Odean (1998) found that framing had little impact on investors' decision making in the
context of individual stock purchases. Similarly, Heath and Tversky (1991) found that framing
had little effect on investors' decisions in a simulated investment task. The authors found that the
way information is framed can influence how people perceive the probability of different
outcomes, which in turn can affect their investment decisions.

One of the studies conducted by De Martino, B., Kumaran, D., Seymour, B., & Dolan, R. J.
(2006) used functional magnetic resonance imaging (fMRI) to investigate the neural mechanisms
involved in decision-making under different framing conditions. The authors found that the neural
activity in the brain differed depending on how the decision was framed, highlighting the
importance of understanding the cognitive processes involved in decision-making.

In one of the recent studies conducted by Oppenheimer, D. M., & Kelso, E. (2015) examined the
effect of framing on decision-making across different cultures. The authors found that the way
information is framed can have a similar effect on decision-making across different cultures,
highlighting the universality of the effect of framing.

Overall, while the results of studies on the effect of framing on investor decision making are mixed,
there is evidence to suggest that framing can influence investor behavior in certain contexts.
However, further research is needed to better understand the specific conditions under which
framing is most likely to have an impact on investor decision making.

Aims and Objectives

This study has two main objectives namely:

1. To test the existence of framing effects in individual investment decision-making processes.
2. To identify loss aversion effects in individual investment decision-making.

Research Methodology

The study adopted a descriptive survey design to test whether investment decisions were frame
dependent and if investors exhibited loss aversion while taking investing and trading decisions.
We decided to conduct both primary and secondary research. The primary research was carried
out through google forms and secondary research was conducted after analyzing various different
literature reviews. The research was conducted on 100 random individual investors who generally
make small investments through trading shares, mutual funds, chit funds, etc and belong from
different age groups, gender, income levels, educational levels, and marital status. We circulated
the form in different investing groups on different social media applications like telegram and
whatsapp as well as family and friends groups requesting the investors to express their views. A
semi structured questionnaire consisting of both open-ended and closed-ended questions was used
to carefully understand the investor’s mindset and spending techniques. The study adopted
scenario analysis by simulating investment decisions to test the framing and loss aversion effects.
We used Excel Data Analysis for the study to study the impact of Income earned by the investors
on the invest in decision

● ANOVA
● CHI SQUARE

Framing effects relate to how a fact or information is expressed. Framing consists of two levels:
positive framing and negative framing. Positive framing is described in terms of potential benefit
(profit) and negative framing depicted in potential loss (loss) terminology. Framing of information
is manipulated for all subjects so that subjects act on one level (positive framing or negative
framing).

Data Analysis Procedure

The study adopted the prospect theory. Investment simulations were presented to respondents to
test if investors were affected by framing and loss aversion effects. The respondents were presented
with two decision problems that were identical in terms of their final wealth. In the first case, the
decision problem was presented as a gain while in the second case; the problem was presented as
a loss. In each decision problem frame there were both a sure outcome and a gamble but both were
identical in terms of their final wealth. A fully rational decision maker would treat the two decision
problems as identical because they were identical when formulated in terms of states of wealth.
Such a decision maker would choose either the gamble or the sure thing in both cases. If there
were inconsistent choices by the respondent, then framing effects were tested. If respondents
inconsistently choose the gamble for the negatively presented decision frame, it indicates that they
were more loss averse, that is - investors weigh losses more heavily than gains. Loss aversion was
tested by computing the mode of the distribution of choices made.

To verify if there were differences in the decisions made due to the differences in the framing, the
chi-square Test with alpha level=0.05 was applied. The research analyzed the applied tests and
their effect in each of the questions asked in the research as provided in the following table.

Effect Test Objective Results indicating the

existing effect

Loss aversion Compare the investment Verify if respondents Significant number of

decisions under two distinct frame events as either respondents inconsistently
perspectives with the same gains or losses and choose the gamble for the
terminal wealth. that they weight losses negatively presented
more heavily than decision frame (Chi square
gains test)

Framing Compare the investment Verify if respondents Significant difference

decisions under two distinct are influenced by the among investment
perspectives with the same framing of a decision decisions. (ANOVA)
terminal wealth. problem
Data Analysis

Now let's try and understand each response.

1. Gender

As we can understand from the above pie chart, we have received responses from 54.1% males
and 45.9% females. We have tried to keep the ratio equal in order to get an idea from both
perspectives.

2. Age

So based on the pie chart, we have 3.5% responses from less than 18 age groups, 23.5% responses
from 18-25 age groups, 47.1% responses from 26 to 35 age group, 21.2% responses from 36 to 45
age group and 4.7% responses from 46 to 55 age group. We didn’t receive any responses from
people above 56 years of age.
Since the responses are from all sorts of age groups, we will be able to conduct our analysis in a
better way understanding different perspectives.

3. Education Level

We have tried to collect responses from a variety of people with different educational levels. We
see that many of the respondents had a level of enlightenment that would necessary to make
rational investment decisions and to respond accordingly to changes in the market as the highest
% of respondents have 70.6%. Followed by undergraduate respondents, i.e. 51.8% comes next.

4. What is your Monthly Income ?

As observed in the above pie chart, 4,7% of the respondents have their monthly income less than
Rs. 25000, 10.6% of the respondents have their monthly income between Rs. 25000 and Rs. 50000.
Majority of them, precisely 43.5% have income ranging from Rs.50000 to Rs. 75000 and 41.2%
of the respondents have monthly income more than Rs. 75000.

5. What is your Marital Status?

As observed in the pie chart above, the majority of the respondents (50.6%) are single. About
45.9% of respondents are married and only 3.5% of the respondents are divorced.

6. Which figure do you think is the longer of the two ?

So we showed two images to our respondents and asked them which figure they think is the
longer of the two. 76.5% of the respondents responded the top figure was longer and the
remaining 23.5% responded the bottom image was longer.

7. What will you choose?

So we gave our respondents two options to choose from, namely, either invest in Stock A for 3
years and get 10% returns or lose 10% return opportunity on Stock A by not investing. 70.6% of
the respondents responded that they would invest in Stock A for 3 years and get 10% returns. The
other 29.4% said they would lose 10% return opportunity.

8. As an investor, which scenario do you think is appealing?

We asked our respondents that as an investor which scenario they think is appealing of the two
which were a. In Q3, the EPS is 1.25, compared to the expected EPS of 1.27 or b. In Q3, the EPS
is 1.25, compared to the Q2 EPS of 1.21. 63.5% of the respondents thought option a was more
appealing and the balance 36.5% considered option b appealing.

9. As an investor, which option is likely to appeal to you more?

We asked our respondents which option they find more attractive: a. Startup A has significantly
increased its revenue from Rs.2 Lac FY’21 to Rs.6 Lac FY’22 pr b. Startup A has significantly
increased its revenue by 200% from FY’21 to FY’22 and 65.9% respondents said they found option
a more attractive than option b.

10. As a trader, which scenario is more appealing?

We asked our respondents which scenario was more appealing to them: a. 90% certainty of stock
price rising by 50 points or b. 10% risk of stock price not rising by 50 points to which 71.8% of
respondents said option a seemed more appealing. The rest considered option b more appealing.

11. Two stocks have the following market outlook:

As an investor, which of the two stocks are you likely to invest in?
We gave two market outlooks and asked our respondents to choose, Investment option 1: Gain of
Rs.800 on shares already purchased and Investment option 2: Gain of Rs.1000, less tax @ 20%.
68.2% of respondents considered Investment option 1 as a more likely option to invest in and the
rest considered Investment option 2.

12. As an investor, which mutual fund is more lucrative?

Respondents were given two mutual fund options, a. Mutual Fund scheme with 3Y absolute returns
of 12% or b. Mutual Fund scheme with 3Y beta of 0.88 with industry beta 0.89. 72.9% of
respondents considered option a more lucrative than option b.
Data Analysis and interpretation

Binary Values assigned to the following variables-

● 1- Positive
● 0- Negative

GROUP 1:
Invest in Stock A for 3 years and get 10% returns- Positive
Lose 10% return opportunity on stock A by not investing- Negative

GROUP 2:
In Q3, the EPS is 1.25, compared to the Q2 EPS of 1.21- Positive
In Q3, the EPS is 1.25, compared to the expected EPS of 1.27- Negative

GROUP 3:
90% certainity of stock price rising by 50 points- Positive
10% risk of stock price not rising by 50 points- Negative

GROUP 4:
Investment option 1: Gain of Rs 800 on shares already purchased- Positive
Investment option 2: Gain of Rs 1000, less tax @ 20%- Negative

Income>Rs.75,000/ ANOVA
Interpretation: The study and the data model for the research proves that Investor’s risk appetite
is not independent of Income when its above Rs.75,000/ pm as we reject the null hypothesis and
accept the alternative hypothesis. Thus, more the income of the investor the more the investor is
ready to take risks and be a risk taker according to the response recorded.
● Average and Variance: From the Summary, you can see the groups have the highest
average (i.e., 0.78) for Group 1 and the highest variance is 0.248571429 obtained for Group
4.
● Test Statistic (F) vs. Critical Value (FCrit): Anova results showcase Statistic (F=
7.394460363) > Critical Statistic (FCrit=2.65067651). Therefore, the data model rejects
the Null Hypothesis.
● P-Value vs. Significance Level (a): Again, from the ANOVA outcomes, the P Value
(0.000101889) < the Significance Level (a = 0.05). So, we can say that the means are
different and reject the Null Hypothesis

Income<Rs.75,000/ ANOVA
Interpretation: The study and the data model for the research proves that Investor’s risk appetite
is not independent of Income when its below Rs.75,000/ pm as we reject the null hypothesis and
accept the alternative hypothesis. Thus, more the income of the investor the more the investor is
ready to take risks and be a risk taker according to the response recorded.

Average and Variance: From the Summary, you can see the groups have the highest average (i.e.,
0.78) for Group 4 and the highest variance is 0.228979592 obtained for Group 1.
Test Statistic (F) vs. Critical Value (FCrit): Anova results showcase Statistic (F= 10.19430815)
> Critical Statistic (FCrit=2.65067651). Therefore, the data model rejects the Null Hypothesis.
P-Value vs. Significance Level (a): Again, from the ANOVA outcomes, the P Value
(0.000002865) < the Significance Level (a = 0.05). So, we can say that the means are different and
reject the Null Hypothesis

CHI SQUARE TEST

Loss Aversion

A question was posed to the respondents as:

The findings show that the majority (73%) of the respondents opted for a sure gain while only 27%
chose to gamble with the gains. This shows that many respondents would prefer sure gains rather
than to gamble and that most respondents are risk averse with gains.

H0: Proportions of income ranges of people are 0.5 each

H1: Proportions of income ranges of people are not 0.5 each

Performing Chi Square Test

P value approach for testing:

Compare p value with significance level 0.05

Since p value is greater than alpha (0.05), do not reject H0

This suggests that H0 holds true, i.e. proportion of the two income ranges of people (less than Rs
75,000pm and more than Rs 75,000pm are equal).

The chi-square test results shows that the differences between the two decision frames were
significant at p<0.05. The findings show that the respondents would reverse their decisions when
the decision problems are presented differently. These inconsistent choices are statistically
significant\
Conclusion

Framing Is a cognitive heuristic, in which people tend to be led to conclusions based on the
"frame," in which a situation has been presented or produced. This framework, the method in
which a perspective is presented, has got a huge influence on people's judgements. In the context
of investment decision making, framing is described as the tendency of investors, in the process
of making investment decisions, to respond differently to an option, dependent on the way it is
presented (formulated) (formulated). The many ways in which information regarding a company's
performance are packaged represent different investing alternatives. When framing can be
identified and comprehended, it may also be manipulated. When investors are careful to the
cognitive influence at problem, they are able to regulate and prevent it. On the other hand, when
investors’ decisions are made in coordination with recognised stock market specialists or other
money market stakeholders, purposefully false or defective investment information might be
discouraged.

Partly no information and inability to spot fake information cause irrational actions and make it
harder for investors to handle financial difficulties. In addition, to prevent framing, it is necessary
that emotion be regulated. The joy resulting from gain-making choices and also the unhappiness
induced by failure can establish frames in information and investment selections. Under this setting
of emotional elation investors may overlook unpleasant and unfavourable information and, in the
context of disappointment induced by failure, acquire excessively cautious and conservative
attitudes. Lastly, impulsive choices can impair logic; impulsive or fast decisions encourage false
information. To conclusion, the above described processes assist investors not to surrender to the
cognitive mistake of framing ; on the contrary, they enable them to notice and cope with misleading
information and, therefore, make sensible investment selections, which will drive to gain
outcomes.

When information is provided in positive framing, decision makers with duties within the group
will tend to pick the less hazardous alternative than the one who has no role in the group. Instead,
when information is provided in negative framing, individuals with no duty in the group prefer to
take risk-seeking options than the individuals who have obligations inside the group 2. The
responsibility faced by a person is able to impact the risk preference for the decision to be done.
Framing no longer has an effect when someone is loaded with duty, people prefer to take fewer
hazardous options when they have responsibility as group leader. Individuals’ investment
decisions are at the riskiest when information is supplied in negative framing with the position as
a member of the group that have no duties inside the group
References

IOSR Journal of Business and Management (IOSR-JBM) e-ISSN: 2278-487X, p-ISSN: 2319-
7668. Volume 20, Issue 9. Ver. VII (September. 2018), PP 45-49 www.iosrjournals.org DOI:
10.9790/487X-2009074549 www.iosrjournals.org 45 | Page Framing And Investment Decision
Making

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Framing And Investment Decision Making DOI: 10.9790/487X-2009074549

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