Prospect Theory

Divide gains and combine losses

Overview

A new value function proposed by Daniel Kahneman and Tversky in 1979, characterized by reference dependence, diminishing sensitivity, and loss aversion.

Behavioral patterns according to the theory

• The emotion of loss depends on the reference point
  • Isn't that why people use Technical Analysis to find out the reference point?
• People prefer a certain gain over an uncertain gain
• People prefer an uncertain loss over a certain loss

Because of this, they sell quickly when stocks rise and hold onto declining stocks for too long

Application strategies

• Divide gains and combine losses
• Combine when gains are large, divide when losses are large
• Pay attention to loss aversion
  • Companies' compensation sales strategies
  • Guide toward providing additional benefits

Examples from companies

• Manipulate it so that a single gain feels like many small discounts, because the utility of one gain is small
• Suppress the intensity of loss through compensation sales

References

• Dong-A Ilbo Prospect Theory

Related Topics

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Topics: economic theory,Loss aversion
Category: Wiki/Economy