Prospect theory is an economic theory which tries to describe the way people will behave when given choices which involve probability.
Prospect theory assumes that individuals make decisions based on expectations of loss or gain from their current relative position.
“An essential feature of Prospect Theory is that carriers of value are changes in wealth or welfare – rather than final outcomes.”
An important element of prospect theory is the idea that individuals are particularly averse to losing what they already have and less concerned to gain.
“Losses loom larger than gains”
Given a choice of equal probability, individuals would choose to preserve their existing wealth, rather than risk the chance to increase wealth.
Prospect theory can explain why people exhibit both risk-seeking and risk-averse behaviour.
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