Working Paper: NBER ID: w18621
Authors: Nicholas C. Barberis
Abstract: Prospect theory, first described in a 1979 paper by Daniel Kahneman and Amos Tversky, is widely viewed as the best available description of how people evaluate risk in experimental settings. While the theory contains many remarkable insights, economists have found it challenging to apply these insights, and it is only recently that there has been real progress in doing so. In this paper, after first reviewing prospect theory and the difficulties inherent in applying it, I discuss some of this recent work. While it is too early to declare this research effort an unqualified success, the rapid progress of the last decade makes me optimistic that at least some of the insights of prospect theory will eventually find a permanent and significant place in mainstream economic analysis.
Keywords: Prospect Theory; Behavioral Economics; Decision Making; Risk; Finance
JEL Codes: D03; D81; G02
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| prospect theory (D81) | understanding of how individuals evaluate risk (D81) |
| loss aversion (G41) | decision-making under risk (D81) |
| loss aversion (G41) | reluctance to accept gambles (D81) |
| loss aversion and risk perceptions (G41) | equity premium puzzle (G12) |
| prospect theory (D81) | different behavior of investors under gains vs losses (G41) |