Good morning! Another week in June comes to a close as this month continues adding to its list of economic twists and turns. While the US and global economy show broad positive growth, we have now entered into trade disputes with a significant portion of the developed world. Following close behind that was the long-awaited meeting between the US and North Korea and the Federal Reserve again raising interest rates. There is certainly no shortage of topics available to form an opinion on how the markets will respond to all of this. Unfortunately, when politics are involved many of the opinions depend on who is framing the question.
This brings us to our next fun topic in Behavioral Finance, the Framing Heuristic. A decision “frame” is the decision maker’s view of the outcomes and risks associated with a particular choice. In trade, our dispute with China could be framed very negatively by the farmers impacted by increased tariffs, but positively for tech companies wanting greater protection of intellectual property rights. This is a very easy one to catch, but some framing is subtler and can affect us all equally.
Here are two questions researchers asked when measuring this.
1.) If you were given $1,000 and then told you could flip a coin where heads would pay you an additional $500 (you walk away with $1,500) and tails would take away $500 (You walk away with $500), would you A.) Play or B.) Walk away with $1,000?
2.) If you were given $1,500 to start and then told $500 would be taken from you or you could flip a coin where heads would let you keep the whole $1,500 and tails meant you lost $1,000. Would you A.) Play or B.) Walk away with $1,000?
What did you decide? How the question is framed can make all the difference. The research has repeatedly shown we are typically prepared to gamble to avoid losses and choose option A for question two but become risk-averse in the context of gains and choose option B for question one.
In poker, this explains why people increase their risk-taking and bet more when they are down. If they quit, they have a guaranteed loss, so they risk an even larger loss all for the chance to get it back.
Let’s face it, when it comes to taking risks, we can all be susceptible to framing. That’s why trying to see something from another point of view really can help!