Thinking, Fast and Slow · chapter 26 · id thinking-fast-and-slow-c26-01-people-evaluate-outcomes-as-ga

“People evaluate outcomes as gains and losses relative to a reference point, not as final wealth states -- contradicting Expected Utility Theory's fundamental assumption (Prospect Theory).”

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Receipts

Kahneman & Tversky (1979), Econometrica 47(2)DOI registry: valid

Prospect Theory proposes that carriers of value are gains and losses relative to a reference point, not final states of wealth. The value function is concave for gains and convex for losses, with a kink at the reference point.

Barberis (2013), Journal of Economic Perspectives 27(1)DOI registry: valid

Thirty-year review concludes prospect theory has been enormously influential and empirically successful in explaining puzzles that Expected Utility Theory cannot: the equity premium puzzle, disposition effect, and insurance purchase patterns.

Tversky & Kahneman (1992), Journal of Risk and Uncertainty 5(4)DOI registry: valid

Cumulative Prospect Theory extended the 1979 model to handle any number of outcomes with rank-dependent probability weighting, resolving technical issues in the original formulation.

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