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Prospect Theory

  1. Andrew Chiu,
  2. George Wu

Published Online: 15 JUN 2010

DOI: 10.1002/9780470400531.eorms0687

Wiley Encyclopedia of Operations Research and Management Science

Wiley Encyclopedia of Operations Research and Management Science

How to Cite

Chiu, A. and Wu, G. 2010. Prospect Theory. Wiley Encyclopedia of Operations Research and Management Science. .

Author Information

  1. University of Chicago Booth School of Business, Center for Decision Research, Chicago, Illinois

Publication History

  1. Published Online: 15 JUN 2010

Abstract

Prospect theory is a descriptive theory of how individuals choose among risky alternatives. The theory challenged the conventional wisdom that economic decision makers are rational expected utility maximizers. We present a number of empirical demonstrations that are inconsistent with the classical theory, expected utility, but can be explained by prospect theory. We then discuss the prospect theory model, including the value function and the probability weighting function. We conclude by highlighting several applications of the theory.

Keywords:

  • probability weighting function;
  • reflection effect;
  • invariance assumption;
  • loss aversion;
  • independence axiom