Prospect Theory: An Analysis of Decision under Risk
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.