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

33 Pages Posted: 10 Jul 2006  

Nicholas Barberis

Yale School of Management; National Bureau of Economic Research (NBER)

Ming Huang

Cornell University - Samuel Curtis Johnson Graduate School of Management

Richard H. Thaler

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Abstract

We argue that "narrow framing," whereby an agent who is offered a new gamble evaluates that gamble in isolation, separately from other risks she already faces, may be a more important feature of decision-making 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 non-expected 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, as well as other related financial puzzles. We confirm these predictions in a simple portfolio choice setting.

Keywords: risk aversion, framing, loss aversion, stock market participation

JEL Classification: D1, D8, G11, G12

Suggested Citation

Barberis, Nicholas and Huang, Ming and Thaler, Richard H., Individual Preferences, Monetary Gambles, and Stock Market Participation: A Case for Narrow Framing. American Economic Review, Vol. 96, No. 4, September 2006. Available at SSRN: https://ssrn.com/abstract=912778

Nicholas Barberis (Contact Author)

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States
203-436-0777 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ming Huang

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States
607-225-9594 (Phone)

Richard H. Thaler

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-5208 (Phone)
773-702-0458 (Fax)

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