Prospect theory

Prospect theory is a descriptive theory of decision-making under risk. It was developed by Daniel Kahneman and Amos Tversky (1979) as a challenge to expected utility theory.

Prospect theory has the following features:

Prospect theory is an “as if” model of decision-making. People do not perform the calculations implicit in the application of prospect theory. Rather, they act “as if” they are performing those calculations. That makes prospect theory a descriptive theory, not a theory of how people actually make decisions.

The following sections break down each of these elements of prospect theory and explain how they are incorporated in its implementation.