Thinking, Fast and Slow

26: Prospect Theory
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subjective value of wealth
: Stanley S. Stevens, “To Honor Fechner and Repeal His Law,”
Science
133 (1961): 80–86. Stevens, 
Psychophysics
.
The three principles
: Writing this sentence reminded me that the graph of the value
function has already been used as an emblem. Every Nobel laureate receives an individual
certificate with a personalized drawing, which is presumably chosen by the committee.
My illustration was a stylized rendition of figure 10.
“loss aversion ratio”
: The loss aversion ratio is often found to be in the range of 1. 5 and

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2.5: Nathan Novemsky and Daniel Kahneman, “The Boundaries of Loss Aversion,”
Journal of Marketing Research
42 (2005): 119–28.
emotional reaction to losses
: Peter Sokol-Hessner et al., “Thinking Like a Trader
Selectively Reduces Individuals’ Loss Aversion,” 
PNAS
106 (2009): 5035–40.
Rabin’s theorem
: For several consecutive years, I gave a guest lecture in the introductory
finance class of my colleague Burton Malkiel. I discussed the implausibility of Bernoulli’s
theory each year. I noticed a distinct change in my colleague’s attitude when I first
mentioned Rabin’s proof. He was now prepared to take the conclusion much more
seriously than in the past. Mathematical arguments have a definitive quality that is more
compelling than appeals to common sense. Economists are particularly sensitive to this
advantage.
rejects that gamble
: The intuition of the proof can be illustrated by an example. Suppose
an individual’s wealth is W, and she rejects a gamble with equal probabilities to win $11
or lose $10. If the utility function for wealth is concave (bent down), the preference
implies that the value of $1 has decreased by over 9% over an interval of $21! This is an
extraordinarily steep decline and the effect increases steadily as the gambles become more
extreme.
“Even a lousy lawyer”
: Matthew Rabin, “Risk Aversion and Expected-Utility Theory: A
Calibration Theorem,” 
Econometrica
68 (2000): 1281–92. Matthew Rabin and Richard H.
Thaler, “Anomalies: Risk Aversion,” 
Journal of Economic Perspectives
15 (2001): 219–
32.
economists and psychologists
: Several theorists have proposed versions of regret theories
that are built on the idea that people are able to anticipate how their future experiences
will be affected by the options that did not materialize and/or by the choices they did not
make: David E. Bell, “Regret in Decision Making Under Uncertainty,” 
Operations
Research
30 (1982): 961–81. Graham Loomes and Robert Sugden, “Regret Theory: An
Alternative to Rational Choice Under Uncertainty,” 
Economic Journal
92 (1982): 805–25.
Barbara A. Mellers, “Choice and the Relative Pleasure of Consequences,” 
Psychological
Bulletin
126 (2000): 910–24. Barbara A. Mellers, Alan Schwartz, and Ilana Ritov,
“Emotion-Based Choice,” 
Journal of Experimental Psychology—General
128 (1999):
332–45. Decision makers’ choices between gambles depend on whether they expect to
know the outcome of the gamble they did not choose. Ilana Ritov, “Probability of Regret:
Anticipation of Uncertainty Resolution in Choice,” 
Organiz {an>y did not ational
Behavior and Human Decision Processes
66 (1966): 228–36.