Preferences with Frames: A New Utility Specification that Allows for the Framing of Risks
39 Pages Posted: 7 Jul 2007
Date Written: June 2007
Experimental work on decision-making shows that, when people evaluate risk, they often engage in narrow framing: that is, in contrast to the prediction of traditional utility functions defined over wealth or consumption, they often evaluate risks in isolation, separately from other risks they are already facing. While narrow framing has many potential applications to understanding attitudes to real-world risks, there does not currently exist a tractable preference specification that incorporates it into the standard framework used by economists. In this paper, we propose such a specification and demonstrate its tractability in both consumption/portfolio choice and equilibrium settings.
Keywords: behavioral finance, diversification, equity premium, utility functions
JEL Classification: D1, D8, G11, G12
Suggested Citation: Suggested Citation