Daniel Kahneman, “Prospect Theory.” Chapter 26, pages 278-288, in Thinking, Fast and Slow, New York: Farrar, Straus and Giroux, 2011.
• Outcomes (the carriers of utility) often seem to be associated with gains or losses relative to some reference point, not to overall states of wealth. Many people can’t generate a precise estimate of their wealth.
• Consider choosing between the prospects (+$900; 1) and (+$1000, $0; .9, .1). They have the same expected value, but we would expect that most people would choose the certainty of gaining $900 to the risky option.
• Now consider choosing between the prospects (-$900; 1) versus (-$1000, $0; .9, .1); many people would choose the risky prospect over the certainty of losing $900. People who are risk averse with respect to gains become risk loving with respect to losses.
• In physical sensations and in many other ways we respond to differences from a reference point. Is a bowl of water warm? The answer depends on the environment, holding the temperature of the water constant.
• Might loss aversion be an evolutionary adaptation, in that threats to the status quo are more urgent than are improvements?
• Consider the prospect (+$x, -$100; .5, .5); how much does x have to be for you to be willing to accept this gamble? For most people, it is between $150 and $250, indicating a “loss aversion ratio” of 1.5 to 2.5.
• Prospect theory ignores anticipated disappointment and regret, though these seem to matter in many actual choices.
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