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Prospect Theory

Definition 1

Model that describes the likelihoods of selecting choice options that differ in risk, probability of occurrence and payoff. Some individuals may be more risk averse in order to be more loss averse, while others may be less risk averse to achieve a larger payoff.

Source: Behavioral Science Lab, 2017

Definition 2

Prospect theory is a behavioral model that shows how people decide between alternatives that involve risk and uncertainty (e.g. % likelihood of gains or losses). It demonstrates that people think in terms of expected utility relative to a reference point (e.g. current wealth) rather than absolute outcomes. Prospect theory was developed by framing risky choices and indicates that people are loss-averse; since individuals dislike losses more than equivalent gains, they are more willing to take risks to avoid a loss.

Source: Behavioral Economics

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