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Individual Preferences, Monetary Gambles, and Stock Market Participation: A Case for Narrow Framing

Nicholas Barberis^1,2; Ming Huang³; Richard H. Thaler^1,4

¹ National Bureau of Economic Research · ² Yale University · ³ Cornell University · ⁴ University of Chicago

We argue that “narrow framing, ” whereby an agent who is offered a new gamble evaluates that gamble in isolation, may be a more important feature of decisionmaking than previously realized. Our starting point is the evidence that people are often averse to a small, independent gamble, even when the gamble is actuarially favorable. We find that a surprisingly wide range of utility functions, including many nonexpected utility specifications, have trouble explaining this evidence, but that this difficulty can be overcome by allowing for narrow framing. Our analysis makes predictions as to what kinds of preferences can most easily address the stock market participation puzzle. (JEL D81, G11) Economists, and financial economists in particular, have long been interested in how people evaluate risk. In this paper, we try to shed new light on this topic. Specifically, we argue that a feature known as “narrow framing ” may play a more important role in decision-making under

DOI

10.1257/000282806779468652

Volume

96 (4)

Pages

1069-1090

Language

en

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