Financial Quotient

What is prospect theory?

Prospect theory is a behavioural model that shows how people decide between alternatives involving risk and uncertainty.

Nobel Prize winner Daniel Kahneman discovered that investors feel more pain from losing a dollar than they feel happiness from gaining that same dollar. In the context of investments, the theory assumes that investors value losses and gains differently, and thus are inclined to make decisions based on perceived gains instead of perceived losses.

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A version of this article appeared in the print edition of The Sunday Times on September 29, 2019, with the headline 'What is prospect theory?'. Print Edition | Subscribe