Prospect Theory

Prospect Theory is a mathematically-formulated alternative to the theory of expected utility maximization.

Expected Utility theory is based on rational behavior of agents and yet has "systematically mispredicted human behavior in at least certain circumstances." (Schiller, 1997)

For instance, Kahneman and Tversky's (1979) lottery experiment.

25% chance of winning $3,000 20% chance of winning $4,000

65% chose latter

But

100% chance of winning $3,000 80% chance of winning $4,000

80% chose former

Prospect Theory similar to Expected Utility Theory in that

Thus, model used zeroing and "one-ing"