When making decisions, individuals may come across various biases or heuristics. These biases can impact their decisions adversely. Usually, biases stem from pre-existing beliefs or how individuals perceive information. These biases may also have an impact on financial decisions. One such bias that may exist in finance is the framing bias.
What is the Framing Bias?
The framing bias stems from the information that individuals use to make decisions. By highlighting specific features of the presented information, individuals may perceive it differently. In other words, the framing bias comes from how an individual’s decision may get influenced by how information gets presented to them.
Framing bias, also known as the framing effect, can influence individuals’ decisions differently for identical scenarios. It may occur when decision-makers choose varying solutions for similar or identical problems. The only difference between both scenarios is the way the information gets presented to them. By doing so, the framing bias can significantly impact the decisions that individuals make in various circumstances.
How does the Framing Bias work?
Framing bias primarily relates to how individuals perceive information. This perception usually depends on how this information gets presented to them. For the same information presented differently, individuals may get differing insights. The framing bias can be significantly influential in any decision-making process. It can also help manipulate individuals’ perceptions of information by altering its presentation.
The framing bias may also relate to anchoring bias, which is when individuals put over-reliance on the first piece of information they receive. As both of these relate to how individuals perceive any information presented to them, they can influence each other. It may also relate to the status-quo bias, where individuals are likely to prefer default options compared to a different choice.
What is the Framing Bias in finance?
As mentioned, the framing bias also applies to investors and other financial decision-makers. Most investors come across various decisions during their activities. Similarly, they also consider several investments before choosing the best option. Sometimes, however, their perception of information may differ based on several factors. This variation in opinion constitutes framing bias.
For example, an investor considers two stocks for investing. The information presented for the first stock states that the investor has a 60% chance of making a loss. The second one shows that the investor has a 40% chance of making a profit. While both have similar probabilities, the investor is likely to consider both options differently due to framing bias. In this case, the investor will choose the second option as the first one presents a high loss percentage.
How to avoid Framing Bias?
Like any other bias or heuristic that may exist, framing bias is also avoidable. Individuals must understand what this bias is and be aware of its existence. By doing so, they can identify any instances where they may allow the presentation of information to impact their decisions. However, there are also other methods that individuals can use to protect against framing bias.
Individuals that make choices can also avoid framing bias by being aware of their decisions. The more information they have about those decisions, the more likely they are to mitigate framing bias. Giving more thought to each decision can significantly help them make well-informed choices. Similarly, individuals can consider the logic for each decision they make to avoid framing bias.
Biases or heuristics may exist in all areas for decision-makes. Framing bias is when individuals allow the presentation of their information to influence their decisions. In other words, it relates to how individuals get presented with information and how they perceive it. It is possible to avoid framing bias through awareness and other methods listed above.