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Tag: prospect-theory

Tag: prospect-theory

10 pages tagged prospect-theory.

Pages

  • Chapter 6: Modern Economic Theories — Economics 101

    Classical economics assumes rational actors in efficient markets. Three modern theories — Minsky’s Financial Instability Hypothesis, New Growth Theory, and Kahneman & Tversky’s Prospect Theory — explain what classical models miss: why stable markets breed crashes, why human capital is the real engine of growth, and why people systematically reject equivalent gains framed as losses.

  • Chapter 25: Bernoulli’s Errors — Thinking, Fast and Slow

    Expected utility theory has dominated economic models of decision-making for 300 years — but it makes a critical error. It judges outcomes by their final states rather than by gains and losses from a reference point. This error is not a detail; it is the foundation of prospect theory.

  • Chapter 26: Prospect Theory — Thinking, Fast and Slow

    Prospect theory replaces expected utility theory with a model of how people actually evaluate outcomes: relative to a reference point, with loss aversion (losses hurt more than equivalent gains help), and diminishing sensitivity in both directions.

  • Chapter 27: The Endowment Effect — Thinking, Fast and Slow

    Owning something changes how you value it — not because the object has changed, but because parting with a possession is coded as a loss, and losses loom larger than equivalent gains. The endowment effect is one of the most replicated demonstrations of loss aversion.

  • Chapter 28: Bad Events — Thinking, Fast and Slow

    Loss aversion is a pervasive feature of human psychology — bad events dominate good ones in nearly every domain of life, from relationships to evolution. The asymmetry between the impact of gains and losses shapes behavior far beyond financial decisions.

  • Chapter 29: The Fourfold Pattern — Thinking, Fast and Slow

    Prospect theory predicts four distinct risk attitudes depending on whether outcomes are gains or losses and whether probabilities are high or low. This fourfold pattern explains apparently contradictory behavior — insurance-buying and lottery-playing by the same person.

  • Chapter 30: Rare Events — Thinking, Fast and Slow

    People overestimate the probability of unlikely events and overweight them in decisions — driven by availability, vividness, and the probability weighting function. This overweighting explains both the purchase of lottery tickets and the fear of terrorism.

  • Chapter 31: Risk Policies — Thinking, Fast and Slow

    Individual risky choices should be evaluated as part of a policy, not in isolation. Narrow framing — evaluating each gamble independently — produces loss-averse choices that are individually defensible but collectively suboptimal. Broad framing corrects this.

  • Chapter 32: Keeping Score — Thinking, Fast and Slow

    Mental accounting — treating money in different accounts as if it were not fungible — produces irrational decision-making. Sunk costs, house money effects, and regret aversion all follow from the way System 1 tracks gains and losses in mental accounts rather than total wealth.

  • Appendix B: Choices, Values, and Frames — Thinking, Fast and Slow

    A condensed version of Kahneman and Tversky’s 1984 American Psychologist paper — the canonical statement of framing effects and prospect theory applied to decision analysis, showing how equivalent descriptions produce systematically different choices.

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