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Prospect Theory
Prospect theory attempts to explain decisions that people make under conditions of uncertainty and risk. Before the development of the theory, it was generally believed that people base decisions on a rationally calculated “expected utility” of the risk and return of various choices. However, Kahneman and Tversky (1979; Tversky & Kahneman, 1981, 1992) provided robust evidence that people’s actual decision-making methods do not tend to follow such rational calculations.
Markowitz (1952) posited the idea that the objects of choice in decision making are prospects that can be defined as either potential gains or losses. This notion is the cornerstone of Kahneman and Tversky’s prospect theory (1979).
There are four important components ...
