Prospect theory, first described in a 1979 paper by Daniel Kahneman and Amos Tversky, is widely viewed as the best available description of how people evaluate risk in experimental settings. While the theory contains many remarkable insights, it has proven challenging to apply these insights in...

Over the past decade, there has been a surge of interest in “tail events” – rare, high-impact events. In this article, I start by summarizing some recent progress in our understanding of the psychology of tail events. I suggest that much of this progress has centered on the concept of...

We conduct a study in which subjects trade stocks in an experimental market while we measure their brain activity using functional magnetic resonance imaging. All of the subjects trade in a suboptimal way. We use the neural data to test a “realization utility” explanation for their behavior....

We propose a new framework for pricing assets, derived in part from the traditional consumption-based approach, but which also incorporates two long-standing ideas in psychology: prospect theory, and evidence on how prior outcomes affect risky choice. Consistent with prospect theory, the...

We show that prospect theory offers a rich theory of casino gambling, one that captures several features of actual gambling behavior. First, we demonstrate that, for a wide range of preference parameter values, a prospect theory agent would be willing to gamble in a casino even if the casino...

Casino gambling is a hugely popular activity around the world, but there are still very few models of why people go to casinos or of how they behave when they get there. In this paper, we show that prospect theory can offer a surprisingly rich theory of gambling, one that captures many features...

Experimental work on decision-making shows that, when people evaluate risk, they often engage in narrow framing: that is, in contrast to the prediction of traditional utility functions defined over wealth or consumption, they often evaluate risks in isolation, separately from other risks they...

We study the asset pricing implications of Tversky and Kahneman's (1992) cumulative prospect theory, with particular focus on its probability weighting component. Our main result, derived from a novel equilibrium with non-unique global optima, is that, in contrast to the prediction of a standard...

We review a recent approach to understanding the equity premium puzzle. The key elements of this approach are loss aversion and narrow framing, two well-known features of decision-making under risk in experimental settings. In equilibrium, models that incorporate these ideas can generate a large...

We argue that narrow framing, whereby an agent who is offered a new gamble evaluates that gamble in isolation, separately from other risks she already faces, may be a more important feature of decision-making under risk than previously realized. To demonstrate this, we present evidence on...