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Psychobabble (talk | contribs) Framing and further implications |
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The '''prospect theory''' was developed by [[Daniel Kahneman]] and [[Amos Tversky]] in [[1979]]. Starting from [[empirical]] evidence, it describes how individuals evaluate [[loss|losses]] and [[gain]]s. In the original formulation the term prospect referred to a [[lottery]].
The theory is basically divided into two stages, editing and evaluation. In the first, the different choices are ordered following some [[heuristic]] so as to let the evaluation phase be more simple. The evaluations around losses and gains are developed starting from a reference point. The value function which passes through this point is s-shaped and as it is asymmetric implies, given the same variation in absolute value, a bigger impact of losses than of gains ([[loss aversion]]). Some behaviors observed in [[economics]], like the disposition effect or the reversing of [[risk aversion]]/[[risk seeking]] in case of gains or losses (termed the ''reflection effect''), can be explained referring to the prospect theory.
An important implication of prospect theory is that the way economic agents subjectively '''frame''' an outcome or transaction in their mind affects the utility they expect or receive. This aspect of prospect theory, in particular, has been widely used in [[behavioural economics]] and [[mental accounting]]. Practical applications of framing and prospect include the [[equity premium puzzle]], the [[status quo bias]], various gambling and betting puzzles, intertemporal consumption and the [[endowment effect]].
Another implication of prospect theory is that [[utility]] is reference based, in contrast with additive utility functions underlying much of [[neo-classical economics]].
* Kahneman, Daniel, and Amos Tversky, “Prospect Theory: An Analysis of Decision under Risk,” Econometrica, XVLII (1979), 263–291.
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