Prospect Theory Model
v1.0
Prospect Theory models decision making under risk using a non-linear value function and distorted probability weighting.
Structural Form
Prospect value equals weighted subjective gains plus weighted subjective losses.
π(p) = exp(−(−ln p)^γ)
V = π(p_gain)·v(gain) + π(p_loss)·v(loss)
Losses are weighted more heavily than gains and probabilities are psychologically distorted.
Assumptions
- • Reference-dependent preferences
- • Loss aversion
- • Non-linear probability weighting
Outputs
- • Prospect value
- • Weighted probabilities
- • Subjective gain and loss values