Prospect Theory And Prospect Theory

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Prospect theory is a descriptive model concerning the issue of decision making under risk. The theory stated that people tend to made decision by examining the potential gain and loss comparing to reference point and exhibit certain kinds of heuristics and biases in this process such as certainty effect, reflection effect, probabilistic insurance and isolation effect. It also divided choice process into editing phases and the subsequent phase of evaluation, which were modified to framing and valuation phases in the later version (Kahneman and Tversky, 1979, Tversky and Kahneman, 1992).
Some defect and weakness of prospect theory were spotted. The original version of prospect theory produces a violation of stochastic dominance(Machina, 1982), …show more content…

A crucial reason in favour of mental accounting and overconfidence is decision efficiency. Real-life investing scenario changes every moment Time-consuming and systematic thinking process seldom is allowed during the intense decision-making (Stewart Jr et al., 1999, Busenitz and Barney, 1997). Additionally, the ‘small world’ used by the economic theory, which only applied to strict condition, is not necessarily applicable in the practical investment decision. As the assumption in those analysis approach may not conform with real life well and for most of times, cognitive heuristics is more suitable for the uncertainty(Gigerenzer and Gaissmaier, 2011). However, there is also a few argument against them, for it may hinder people from examining their investment choice thoroughly. Research shows that they did not perceive themselves as risk taker, but in fact, they are more likely to take relatively low return alternatives as ‘opportunities’, indicating that they are risk-taking to a great extent(Palich and Ray Bagby, 1995). As a result of the illusion created by such factors, decision makers tend to be narrow-minded in composing strategies and unable to bring enough information into thought(Schwenk, 1988). It was demonstrated by several researches that decisions made by means of biases and heuristics impose …show more content…

One reason is that many successful investment ventures itself is the outcome of these ‘irrationality’. Risk-taking, which is inevitable in investment, may contribute to the investors’ better performance than others, while with the assistance of proper training, assessment accuracy can be increased(Palich and Ray Bagby, 1995). Also, if without precedent, most of the newly-invented value-maximising approaches or strategy of investment ought to be considered as crude and unthoughtful, but in reality, they are regarded as innovation(Busenitz and Barney, 1997). Furthermore, there are evidence shows that instead of being the hindrance of correct investment decision-making, those biases and heuristics are backed up by probabilistic information. Accurate statistical probability can be evaluated by our inductive reasoning mechanism with a relatively high possibility(Cosmides and Tooby,

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