Prospect theory: analysis of decision under risk
About: This article is published in Econometrica.The article was published on 1979-01-01 and is currently open access. It has received 27773 citations till now. The article focuses on the topics: Prospect theory & Cumulative prospect theory.
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TL;DR: The psychological principles that govern the perception of decision problems and the evaluation of probabilities and outcomes produce predictable shifts of preference when the same problem is framed in different ways.
Abstract: The psychological principles that govern the perception of decision problems and the evaluation of probabilities and outcomes produce predictable shifts of preference when the same problem is framed in different ways. Reversals of preference are demonstrated in choices regarding monetary outcomes, both hypothetical and real, and in questions pertaining to the loss of human lives. The effects of frames on preferences are compared to the effects of perspectives on perceptual appearance. The dependence of preferences on the formulation of decision problems is a significant concern for the theory of rational choice.
15,513 citations
TL;DR: Cumulative prospect theory as discussed by the authors applies to uncertain as well as to risky prospects with any number of outcomes, and it allows different weighting functions for gains and for losses, and two principles, diminishing sensitivity and loss aversion, are invoked to explain the characteristic curvature of the value function and the weighting function.
Abstract: We develop a new version of prospect theory that employs cumulative rather than separable decision weights and extends the theory in several respects. This version, called cumulative prospect theory, applies to uncertain as well as to risky prospects with any number of outcomes, and it allows different weighting functions for gains and for losses. Two principles, diminishing sensitivity and loss aversion, are invoked to explain the characteristic curvature of the value function and the weighting functions. A review of the experimental evidence and the results of a new experiment confirm a distinctive fourfold pattern of risk attitudes: risk aversion for gains and risk seeking for losses of high probability; risk seeking for gains and risk aversion for losses of low probability. Expected utility theory reigned for several decades as the dominant normative and descriptive model of decision making under uncertainty, but it has come under serious question in recent years. There is now general agreement that the theory does not provide an adequate description of individual choice: a substantial body of evidence shows that decision makers systematically violate its basic tenets. Many alternative models have been proposed in response to this empirical challenge (for reviews, see Camerer, 1989; Fishburn, 1988; Machina, 1987). Some time ago we presented a model of choice, called prospect theory, which explained the major violations of expected utility theory in choices between risky prospects with a small number of outcomes (Kahneman and Tversky, 1979; Tversky and Kahneman, 1986). The key elements of this theory are 1) a value function that is concave for gains, convex for losses, and steeper for losses than for gains,
13,433 citations
Cites background from "Prospect theory: analysis of decisi..."
...Some time ago we presented a model of choice, called prospect theory, which explained the major violations of expected utility theory in choices between risky prospects with a small number of outcomes (Kahneman and Tversky, 1979; Tversky and Kahneman, 1986)....
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TL;DR: In this paper, the authors draw on the social and behavioral sciences in an endeavor to specify the nature and microfoundations of the capabilities necessary to sustain superior enterprise performance in an open economy with rapid innovation and globally dispersed sources of invention, innovation, and manufacturing capability.
Abstract: This paper draws on the social and behavioral sciences in an endeavor to specify the nature and microfoundations of the capabilities necessary to sustain superior enterprise performance in an open economy with rapid innovation and globally dispersed sources of invention, innovation, and manufacturing capability. Dynamic capabilities enable business enterprises to create, deploy, and protect the intangible assets that support superior long- run business performance. The microfoundations of dynamic capabilities—the distinct skills, processes, procedures, organizational structures, decision rules, and disciplines—which undergird enterprise-level sensing, seizing, and reconfiguring capacities are difficult to develop and deploy. Enterprises with strong dynamic capabilities are intensely entrepreneurial. They not only adapt to business ecosystems, but also shape them through innovation and through collaboration with other enterprises, entities, and institutions. The framework advanced can help scholars understand the foundations of long-run enterprise success while helping managers delineate relevant strategic considerations and the priorities they must adopt to enhance enterprise performance and escape the zero profit tendency associated with operating in markets open to global competition. Copyright 2007 John Wiley & Sons, Ltd.
9,400 citations
Cites background from "Prospect theory: analysis of decisi..."
...This approach to decision making may produce inconsistent preferences and decision biases (timid choices) that lead to outcomes that block innovation (Kahneman and Tversky, 1979; Kahneman and Lovallo, 1993)....
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TL;DR: In this article, the authors focus on the linkages between the industry analysis framework, the resource-based view of the firm, behavioral decision biases and organizational implementation issues, and connect the concept of Strategic Industry Factors at the market level with the notion of Strategic Assets at the firm level.
Abstract: We build on an emerging strategy literature that views the firm as a bundle of resources and capabilities, and examine conditions that contribute to the realization of sustainable economic rents. Because of (1) resource-market imperfections and (2) discretionary managerial decisions about resource development and deployment, we expect firms to differ (in and out of equilibrium) in the resources and capabilities they control. This asymmetry in turn can be a source of sustainable economic rent. The paper focuses on the linkages between the industry analysis framework, the resource-based view of the firm, behavioral decision biases and organizational implementation issues. It connects the concept of Strategic Industry Factors at the market level with the notion of Strategic Assets at the firm level. Organizational rent is shown to stem from imperfect and discretionary decisions to develop and deploy selected resources and capabilities, made by boundedly rational managers facing high uncertainty, complexity, and intrafirm conflict.
8,121 citations
Cites background from "Prospect theory: analysis of decisi..."
...Further, their judgements and choices are likely to exhibit idiosyncratic aversions to risk and ambiguity (Kahneman and Tversky, 1979; Einhorn and Hogarth....
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...The predicted bias is toward risk-seeking for R&C that are deemed to be below some chosen reference point and toward risk-arjersion for those that exceed this aspiration level (see Kahneman and Tversky, 1979)....
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TL;DR: The results reveal that happiness is associated with and precedes numerous successful outcomes, as well as behaviors paralleling success, and the evidence suggests that positive affect may be the cause of many of the desirable characteristics, resources, and successes correlated with happiness.
Abstract: Numerous studies show that happy individuals are successful across multiple life domains, including marriage, friendship, income, work performance, and health. The authors suggest a conceptual model to account for these findings, arguing that the happiness-success link exists not only because success makes people happy, but also because positive affect engenders success. Three classes of evidence--crosssectional, longitudinal, and experimental--are documented to test their model. Relevant studies are described and their effect sizes combined meta-analytically. The results reveal that happiness is associated with and precedes numerous successful outcomes, as well as behaviors paralleling success. Furthermore, the evidence suggests that positive affect--the hallmark of well-being--may be the cause of many of the desirable characteristics, resources, and successes correlated with happiness. Limitations, empirical issues, and important future research questions are discussed.
5,713 citations
Cites background from "Prospect theory: analysis of decisi..."
...Furthermore, there may be a resetting point around a person’s current circumstances so that people are most likely to react with negative affect when conditions worsen from their current state (Kahneman & Tversky, 1979)....
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