Prospect Theory: An Analysis of Decision under Risk
Daniel Kahneman, Amos Tversky
Summary
Kahneman and Tversky presented experimental evidence that people systematically violate the axioms of expected utility theory when choosing among risky prospects, and proposed prospect theory as a descriptive alternative. In their model, outcomes are evaluated as gains and losses relative to a reference point through an S-shaped value function that is concave for gains, convex for losses, and steeper for losses (loss aversion), while objective probabilities are transformed by a nonlinear decision-weighting function that overweights small probabilities. The theory accounts for observed anomalies such as the certainty, reflection, and isolation effects.
Key findings
- Documented systematic departures from expected utility theory, including the certainty effect and the reflection effect (risk aversion for gains but risk seeking for losses).
- Proposed a value function defined over gains and losses from a reference point—concave for gains, convex for losses, and steeper for losses—formalizing loss aversion.
- Introduced decision weights that nonlinearly transform probabilities, overweighting low probabilities and underweighting moderate-to-high ones, explaining framing and isolation effects.
Subjects & keywords
Cite this paper
Daniel Kahneman, & Amos Tversky (1979). Prospect Theory: An Analysis of Decision under Risk. Econometrica. https://doi.org/10.2307/1914185
@article{kahneman1979prospect,
author = {Daniel Kahneman and Amos Tversky},
title = {Prospect Theory: An Analysis of Decision under Risk},
journal = {Econometrica},
year = {1979},
doi = {10.2307/1914185},
url = {https://doi.org/10.2307/1914185}
}