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

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  • Nicholas Barberis
  • Ming Huang
  • Richard H. Thaler

Abstract

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)

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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 96 (2006)
Issue (Month): 4 (September)
Pages: 1069-1090

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Handle: RePEc:aea:aecrev:v:96:y:2006:i:4:p:1069-1090

Note: DOI: 10.1257/aer.96.4.1069
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  1. Larry G. Epstein & Stanley E. Zin, 1991. "The Independence Axiom and Asset Returns," NBER Technical Working Papers 0109, National Bureau of Economic Research, Inc.
  2. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  3. Epstein, Larry G. & Zin, Stanley E., 1990. "'First-order' risk aversion and the equity premium puzzle," Journal of Monetary Economics, Elsevier, vol. 26(3), pages 387-407, December.
  4. Larry Epstein & Martin Schneider, 2002. "Learning Under Ambiguity," RCER Working Papers 497, University of Rochester - Center for Economic Research (RCER), revised Mar 2005.
  5. Gul, Faruk, 1991. "A Theory of Disappointment Aversion," Econometrica, Econometric Society, vol. 59(3), pages 667-86, May.
  6. Nicholas Barberis & Ming Huang, 2006. "The Loss Aversion / Narrow Framing Approach to the Equity Premium Puzzle," NBER Working Papers 12378, National Bureau of Economic Research, Inc.
  7. Andrew Ang & Geert Bekaert & Jun Liu, 2000. "Why Stocks May Disappoint," NBER Working Papers 7783, National Bureau of Economic Research, Inc.
  8. Nicholas Barberis & Ming Huang & Richard Thaler, 2003. "Individual Preferences, Monetary Gambles and the Equity Premium," NBER Working Papers 9997, National Bureau of Economic Research, Inc.
  9. Haliassos, Michael & Bertaut, Carol C, 1995. "Why Do So Few Hold Stocks?," Economic Journal, Royal Economic Society, vol. 105(432), pages 1110-29, September.
  10. Nicholas Barberis & Ming Huang & Tano Santos, 2001. "Prospect Theory And Asset Prices," The Quarterly Journal of Economics, MIT Press, vol. 116(1), pages 1-53, February.
  11. Alma Cohen & Liran Einav, 2005. "Estimating Risk Preferences from Deductible Choice," NBER Working Papers 11461, National Bureau of Economic Research, Inc.
  12. Raj Chetty, 2004. "Consumption Commitments, Unemployment Durations, and Local Risk Aversion," NBER Working Papers 10211, National Bureau of Economic Research, Inc.
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