Prospect Theory: An Analysis of Decision under Risk

Prospect Theory explains how people make decisions involving risk and uncertainty. Unlike traditional models that assume people are always rational, it shows individuals evaluate potential gains and losses differently—losses often feel more impactful than equivalent gains. People tend to be risk-averse with gains (preferring certain outcomes) but risk-seeking with losses (willing to take bigger risks to avoid losses). Additionally, individuals weigh probabilities non-linearly, overestimating small chances and underestimating large ones. Overall, Prospect Theory provides a realistic framework for understanding the often inconsistent and emotionally influenced decisions people make under risk.