Enter the characters you see below Sorry, we just need to make sure you’re not a robot. Please forward this error screen to sharedip-1071802217. Daniel Kahneman, who won a Nobel Memorial Prize in Economics for his work developing prospect theory. Prospect theory is a theory in cognitive psychology that describes the way people how to evaluate utility stocks between probabilistic alternatives that involve risk, where the probabilities of outcomes are uncertain.

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During an initial phase termed editing, outcomes of a decision are ordered according to a certain heuristic. In particular, people decide which outcomes they consider equivalent, set a reference point and then consider lesser outcomes as losses and greater ones as gains. The value function that passes through the reference point is s-shaped and asymmetrical. The value function is steeper for losses than gains indicating that losses outweigh gains. This differs from expected utility theory, in which a rational agent is indifferent to the reference point. The value function is thus defined on deviations from the reference point, generally concave for gains and commonly convex for losses and steeper for losses than for gains. This means that for a fixed ratio of probabilities the decision weights are closer to unity when probabilities are low than when they are high.

Although direct violations of dominance never happen in prospect theory, it is possible that a prospect A dominates B, B dominates C but C dominates A. To see how prospect theory can be applied, consider the decision to buy insurance. If we apply prospect theory, we first need to set a reference point. In this case, the concavity of the value function in gains and the underweighting of high probabilities can also lead to a preference for buying the insurance. Below is an example of the fourfold pattern of risk attitudes. The second item in the quadrant shows the focal emotion that the prospect is likely to evoke.