Tversky and Kahnemann: Framing of Decisions

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Tversky and Kahnemann: Framing of Decisions. Agenda: Expected Utility Theory Violations of EU’s axioms of choice: Framing Effects Nontransparent Dominance Certainty and Pseudocertainty Effects Tradeoff Contrast Extremeness Aversion - PowerPoint PPT Presentation

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  • Tversky and Kahnemann: Framing of DecisionsAgenda:Expected Utility TheoryViolations of EUs axioms of choice: Framing EffectsNontransparent DominanceCertainty and Pseudocertainty EffectsTradeoff ContrastExtremeness AversionConflict between descriptive and normative theories and conclusion

  • Expected Utility TheoryNormative model of the modern theory of decision making under risk (Neumann & Morgenstern)Four substantive assumptions:1. Cancellationelimination of any state of the world that yields the same outcome regardless of ones choice necessary for the representation of preference between prospects as the maximization of expected utility - (highly challenged and questioned)

  • Expected Utility Theory2. Transitivity of preferencenecessary for the representation of preference by an ordinal utility scale u such that A is preferred to B whenever u(A) > u(B); (independent on other available options - (questioned)3. Dominanceif one option is better than another in one state and at least as good in all other states, the dominant option should be chosen - (simple, compelling and accepted)4. Invariancedifferent representations of the same choice problem should yield the same preference, independent of their description - (basic principle, tacitly assumed, accepted)

  • Problem: Violations of axioms of choiceSeveral experiments have proven that the deviations of actual behavior from the normative model are too widespread to be ignored, too systematic to be dismissed as random error, and too fundamental to be accommodated by relaxing the normative system (Tversky & Kahnemann), e.g. Allais Paradox (1953); Ellsberg Paradox (1961)...Theory of rational decision cannot provide adequate description of choice behaviorKahnemann & Tversky (1979) developed an alternative outcome-based approach called PROSPECT THEORY in order to explain many of the EU anomalies

  • FramingExpected utility theory assumes description invariance: different formulations of the same choice problem should give rise to the same preference orderEvidence that variations in the framing of options (in the description) yield systematically different preferencesFraming effects lead to violation of the invariance and the dominance axioms of expected utility theory

  • Nontransparent DominanceLottery Example: Choose from a box with differently coloured marblesProblem 1 (N=88)Option A: 90% white 6% red 1% green 1% blue 2% yellow $0 win $45 win $30 lose $15 lose $15Option B: 90% white 6% red 1% green 1% blue 2% yellow $0 win $45 win $45 lose $10 lose $15 Problem 2 (N=124)Option C: 90% white 6% red 1% green 3% yellow $0 win $45 win $30 lose $15Option D: 90% white 7% red 1% green 2% yellow $0 win $45 lose $10 lose $15 [0%][100%][58%][42%]

  • Nontransparent DominanceResults of Lottery Example:Two formulations of the same problem elicit different preferences (violation of invariance)finer partition used in problem 1the number of positive and negative outcomes alone can enhance the attractiveness of an option (option C)Dominance rule is obeyed only when its application is transparentDominance can be masked by a frame

  • Nontransparent DominanceTransparency in a Perceptual Example: Mller-Lyer-Illusion

    whether relation of dominance is detected depends onFraming (transparency)Details of partitioningSophistication and experience of decision maker

  • Certainty and Pseudocertainty EffectsProblem 1 (N=77): Which of the following options do you prefer?A. sure gain of $30B. 80% chance to win $45, 20% chance to win nothingProblem 2 (N=81): Which of the following options do you prefer?C. 25% chance to win $30, 75% chance to win nothingD. 20% chance to win $45, 80% chance to win nothing

  • Certainty EffectProblem 1 and 2 : In problem 2, the probabilities of winning are reduced by a factor of fourPreference switched due to certainty effect: Reduction of probability of winning from certainty to 0.25 has greater effect than the reduction from 0.8 to 0.2

  • Certainty and Pseudocertainty EffectsProblem 1 (N=77): Which of the following options do you prefer?A. sure gain of $30B. 80% chance to win $45, 20% chance to win nothingProblem 2 (N=81): Which of the following options do you prefer?C. 25% chance to win $30, 75% chance to win nothingD. 20% chance to win $45, 80% chance to win nothingProblem 3 (N=85): Two-stage gameStage 1: 75% chance to end the game without winning anything, 25% chance to move to stage 2Stage 2:E. sure win of $30F. 80% chance to win $45, 20% chance to win nothing

  • Pseudocertainty EffectProblem 2 and 3 : Identical in terms of probabilities and outcomesFraming as two-stage game encourages the application of cancellation: Failing to reach second step is discarded

    Pseudocertainty Effect: Risk-averse choice in problem 3 but not in 2, outcome that is actually uncertain (3) is weighted as if it were certain

  • Certainty and Pseudocertainty EffectsProblem 1:Overweighing of the outcome that is obtained with certainty due to loss aversionProblem 2:Reduces probability of winning by factor of 4Problem 3:Introduces ex ante stage that gives 25% chance for second stageDifferent choice due to certainty effect; violation of cancellationApplication of cancellation - same choice as in problem 1; risk-averse choice due to pseudocertaintySame problem, differently framed

  • Framing - FindingsAxioms of rational choice aregenerally satisfied in transparent situationsoften violated in nontransparent situationsFraming enriches and complicates analysis of choiceFraming of decisions depends onLanguage of presentationNature of displayContext of choice

  • Simonson and Tversky (1992): Value MaximizationBasic assumption of classical economic theory: Consumer selects alternative with highest value, preference is independent of the contextBUT: consumer preferences are influenced by context of choiceEffects of Context on Choice:1. TRADEOFF CONTRAST2. EXTREMENESS AVERSION

  • 1. Tradeoff ContrastPeople tend to compare an available option to other choices that are currently available (Local Effect) options that have been encountered in the past (Background Effect)e.g. a circle appears large when surrounded by small circles and small when surrounded by large ones

    Applies to single attributes (e.g. size) as well as to tradeoffs between attributes (e.g. price and quality)

  • Local EffectIf y is clearly superior to z but x is not:Tradeoff Contrast Hypothesis implies:

    Addition of z can increase ys market share, yielding:Violates value maximization principle: popularity of an option cannot be increased by enlarging the offered set Asymmetric Dominance Effect

  • Enhancement & DetractionEnhances the attractiveness of y; y fares better in triple than in pairs (explained by extremeness aversion)Assumption: no strong preference between x and z; z is dominated by y but not by x Tradeoff Contrast Hypothesis: offered set will affect choice even when no option has a decisive advantage over anotherDetracts from the attractiveness of w; w fares worse in triple than in pairsOnce a third option is introduced, the decision maker can compare three tradeoffs, which...

  • 2. Extremeness Aversion (1/3)Implications of value maximization: If y is between x and z on all relevant attributes, then

    Middle option (y) is expected to lose relatively more than the other extreme option x from the introduction of zAt variance with extremeness aversion: y will lose relatively less than x from the introduction of z

  • Extremeness Aversion (2/3)Main features:An option is more attractive to the respondent if it is an intermediate option in a choice setAttractiveness is lower for extreme optionsBased on Principle of Loss Aversion: losses loom larger than gainsAlternatives are evaluated in terms of their advantages and disadvantages relative to other options; disadvantages are weighted more heavily than advantages

  • Extremeness Aversion (3/3) Each extreme option (x and z) has a large advantage and a large disadvantage relative to the other extreme; small advantage and small disadvantage relative to the middle option (y)Middle option (y) has small advantages and small disadvantages relative to both extremesIf (pairwise) disadvantages loom larger than the corresponding advantages, the middle option should fare better in the triple than in the pairs.

  • Example for Extremeness AversionIn group 1 & 2, the cameras varied across three dimensions: two qualitative dimensions (optics, resolution)one price dimensionGroup 3: introduction of a forth dimension (recording of video sequences) for camera 3 in order to emphasize its quality and innovativeness

    Tabelle1

    group 1group 2group 3

    cam. 1cam. 2cam. 1cam. 2cam. 3cam. 1cam. 2cam. 3

    people interviewed262624

    absolute number101621953129

    relative number0.3850.6150.0770.7310.1920.1250.50.375

    Tabelle2

    Tabelle3

  • TheoryFraming effects and associated failures of invariance are ubiquitous - cant be ignored by adequate descriptive theoryInvariance is normatively indispensable - no adequate prescriptive theory should permit its violationSeems unrealizable to construct a theory that is both descriptively an