Prospect theory

Prospect theory 2018-07-05T15:42:59+00:00

Prospect theory is a behavioral model that shows how people decide between alternatives that involve risk and uncertainty (e.g. % likelihood of gains or losses). It demonstrates that people think in terms of expected utility relative to a reference point (e.g. current wealth) rather than absolute outcomes. Prospect theory was developed by framing risky choices and indicates that people are loss-averse; since individuals dislike losses more than equivalent gains, they are more willing to take risks to avoid a loss. Due to the biased weighting of probabilities (see certainty/possibility effects) and loss aversion, the theory leads to the following pattern in relation to risk (Kahneman & Tversky, 1979; Kahneman, 2011):


(Certainty Effect)
95% chance to win $10,000

Fear of disappointment

95% chance to lose $10,000

Hope to avoid loss


(Possibility Effect)
5% chance to win $10,000

Hope of large gain

5% chance to lose $10,000

Fear of large loss


Kahneman, D. (2011). Thinking, fast and slow. London: Allen Lane.

Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk. Econometrica, 47, 263-291.

Send this to a friend