Prospect Theory: How Humans Evaluate Risk and Uncertainty
Prospect theory is a behavioral model of decision-making under uncertainty that explains how people evaluate outcomes relative to reference points, weigh losses more heavily than equivalent gains, and distort probabilities in systematic ways. This article examines the theory’s origins in the work of Kahneman and Tversky, its treatment of framing, loss aversion, and the value function, its role in behavioral economics, and its applications in finance, public policy, and sustainability governance. It also develops a formal analytical framework and includes substantial R and Python sections with fully commented code for simulating reference dependence, asymmetric valuation, and risk choice. The broader argument is that prospect theory did not merely refine classical decision theory, but fundamentally reoriented the descriptive study of economic choice under risk toward psychology, context, and reference-dependent judgment.









