Seonglae ChoKahneman-Tversky Prospect theory
A model that explains people's actual choice behavior in risky situations. Unlike Expected Utility Theory which assumes "rational" choices, Prospect Theory focuses on how people perceive gains and losses asymmetrically and non-linearly
Reference Point
People distinguish between gains and losses based on their current state or Expectation, rather than absolute wealth or probability.
Value Function
In the gain domain, the function is concave and gradually becomes less sensitive, while in the loss domain, it is convex and steeper than for gains. This means losses have a greater psychological impact than equivalent gains (loss aversion).
Probability Weighting
People tend to overweight low probabilities and underweight high probabilities.
Two Stages of Decision Making
- Editing: Simplifying options and framing them as 'gains'/'losses' relative to the reference point
- Evaluation: Calculating the overall 'prospect value' by applying the value function and probability weighting function
