Prospect Theory Flashcards
A theory of the psychology of choice and finds application in behavioral economics and behavioral finance. Based on results from controlled studies, it describes how individuals assess their loss and gain perspectives in an asymmetric manner (see loss aversion). (Ex), for some individuals, the pain from losing $1,000 could only be compensated by the pleasure of earning $2,000. Thus, contrary to the expected utility theory, prospect theory aims to describe the actual behavior of people.
Prospect theory
Prospect theory is a theory of the psychology of choice and finds application in behavioral economics and behavioral finance. It was developed by Daniel Kahneman and Amos Tversky in 1979. The theory was cited in the decision to award Kahneman the 2002 Nobel Memorial Prize in Economics.
Based on results from controlled studies, it describes how individuals assess their loss and gain perspectives in an asymmetric manner (see loss aversion). For example, for some individuals, the pain from losing $1,000 could only be compensated by the pleasure of earning $2,000. Thus, contrary to the expected utility theory (which models the decision that perfectly rational agents would make), prospect theory aims to describe the actual behavior of people.
Ambiguity effect
The tendency to avoid options for which the probability of a favorable outcome is unknown.
Disposition effect
The tendency to sell an asset that has accumulated in value and resist selling an asset that has declined in value.
Dread aversion
Just as losses yield double the emotional impact of gains, dread yields double the emotional impact of savouring.
Endowment effect
The tendency for people to demand much more to give up an object than they would be willing to pay to acquire it.
Loss aversion
The perceived disutility of giving up an object is greater than the utility associated with acquiring it. (see also Sunk cost effects and endowment effect).
Pseudocertainty effect
The tendency to make risk-averse choices if the expected outcome is positive, but make risk-seeking choices to avoid negative outcomes.
Status quo bias
The tendency to like things to stay relatively the same (see also loss aversion, endowment effect, and system justification).
System justification
The tendency to defend and bolster the status quo. Existing social, economic, and political arrangements tend to be preferred, and alternatives disparaged, sometimes even at the expense of individual and collective self-interest. (See also status quo bias.)
