Prospect Theory

Prospect theory is a descriptive theory of risky choice proposed by the psychologists Daniel Kahneman and Amos Tversky in 1979 and revised in 1992. Like subjective expected utility theory (SEU), prospect theory is a probability-weighted additive utility model: Risky options are evaluated by adding up the utilities of the possible outcomes after weighting each by a factor that reflects the decision maker's belief about how likely each outcome is to occur. Like SEU, prospect theory can be mathematically derived from a simpler set of axioms about preference judgments and can provide predictions about choice behavior. Prospect theory, however, has several key differences from SEU that enable it to better account for observed systematic violations of axioms and predictions of SEU that were widely documented by ...