MENTAL MODEL · M4703

Prospect Theory

BehaviorHigh supportPsychology

Included

Version 1.0.0 · Updated 2026-07-30

CORE DEFINITION

Describes people's decision-making behavior when facing risk and uncertainty, finding that people are more sensitive to losses than gains (loss aversion), and that decisions are influenced by factors such as reference points and probability weighting.

SCAFFOLDING EFFECT

psychology

Reduce cognitive load

Understanding the psychological mechanisms of risk decision-making. Prospect theory explains why people make seemingly irrational insurance and gambling decisions, providing an important psychological foundation for financial product design, insurance pricing, and policy-making.

anchor

Anchor fast decisions

Kahneman and Tversky proposed that the value function is centered on a 'reference point' (usually the status quo or expected value), being concave for gains and convex for losses, so the pain of losses is greater than the pleasure of equivalent gains (loss aversion); simultaneously, people systematically distort probabilities—overweighting small probabilities and underweighting moderate to high probabilities (decision weight function), leading to overreaction to extreme events.

MINIMUM ACTION

In progress 0/4

Practice this model in one real situation:

Clarify the decision-maker's current reference point (status quo or expectation) rather than absolute wealth
Identify whether the same problem is framed as 'gains' or 'losses'
Note that framing effects can alter choices, and proactively reframe the problem in both frames
Use the probability weighting function to correct intuitive biases regarding small-probability events (lotteries, insurance).

Check to track your progress (stored locally)

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Source support: Explicit

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en.wikipedia.orghttps://en.wikipedia.org/wiki/Prospect_theoryZH · Explicit
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