Prospect theory comes from behavioral economics and is credited to Daniel Kahneman and Amos Tversky and their 1979 paper “Prospect Theory: An Analysis of Decision under Risk,” in which they argue individuals assess gains and losses in asymmetric ways. In other words, there is more aversion to loss than inclination toward gains. This tendency, they argue, contributes to risk aversion in choices involving sure gains and to risk-seeking in choices involving sure losses.
This has real-world effects in that the overweighting of low probabilities may contribute to the attractiveness of insurance and gambling.
This theory stands in contrast to expected utility theory, which expects people to act the same in terms of loss and gains and to always try to maximize utility; yet, prospect theory holds up under rigorous studies in the real world, as opposed to expected utility theory.
Citations: Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk. Econometrica, 47(2), 263-291. doi:10.2307/1914185
Post, T., Van den Assem, M., Baltussen, G., & Thaler, R. (2008). Deal or no deal? Decision making under risk in a large-payoff game show. The American Economic Review, 98(1), 38-71. Retrieved February 22, 2021, from http://www.jstor.org/stable/29729963