Prospect Theory and Financial Decision Making

Prospect Theory is a behavioral economics concept that explains how people make decisions under uncertainty. It suggests that individuals value gains and losses differently; specifically, losses often feel more impactful than equivalent gains. This means people tend to avoid risks when they think they might gain but become risk-seeking when facing potential losses. In financial decision-making, this can lead to choices that seem irrational, such as holding onto losing investments too long or selling winning ones too quickly. Overall, Prospect Theory helps explain why people's financial choices can deviate from traditional economic models of rational behavior.