Question

Explain all the different original components of Prospect Theory and compare it to expected utility theory. In your answer you should also discuss the strength and weaknesses of Prospect Theory.

Answer 1

The Prospect Theory starts with the concept of Loss Aversion, an symmetric form of risk aversion, which is a observation that people react differently between potential losses & potential gains. In relation to the specific situation, people make decisions. The prospect Theory is an Economics theory developed by Daniel Kahneman & Amosn Tversky in 1979, It is the founded theory of behavioral economics & behavioural finance, & constitutes first economic theories built using experimental methods. An important implication of prospect theory is that the way economic agents subjectively frame an outcome or saction in their mind affects the utility they expect or receive, Farming & prospect theory applied to diverse range of situations which appear inconsistent with standard economic rationality. Prospect theory is a theory of decision making under conditions of risks,based on judgement. It is the individuals choice in relation to probabilistic alternatives where risk is involved & the probability of different outcomes is unknown. The isolation effect occurs when people have presented two options with the same outcome, but different routes to the outcome.

The prospect theory has helped to explain many of the behaviour pattern , its allows one to describe how people make choices in situations where they have to decide between alternatives that involve risk in financial decisions. Not Really Expandable,Kahneman & Tverski Importantly noted that the theory was developed for one & the research challenges prospects theories to dynamic situations. Coding process Fragility; The decision making process detailed in the coding process which , the process is highly susceptible to how problems are framed & projected by the norms ,habits & expectations of the decision maker. Real World Anomalies,there have both included academic & real world subjects & situations empirical studies that contradict the prospect theory. Further research is needed to refine prospect theory.