Prospect Theory
How people actually make decisions under uncertainty
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What is Prospect Theory?
- In 1979, psychologists Daniel Kahneman and Amos Tversky proposed an alternative to classical expected utility theory. Their insight: people don't evaluate outcomes in absolute terms—they evaluate gains and losses relative to a reference point.
- This simple shift explains a wide range of "irrational" behaviors: why people buy lottery tickets AND insurance, why investors hold losers too long, why a $10 discount matters more on a $20 item than a $1,000 item.
- Prospect theory has four key components. Let's walk through each one.
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