NISM Certifications · NISM-Series-X-B: Investment Adviser (Level 2) · Basics of Behavioural Finance
Prospect theory, developed by Kahneman and Tversky, differs from expected utility theory mainly because it proposes that people:
Prospect theory holds that people judge outcomes as gains or losses relative to a reference point, and feel losses more strongly than equal gains, unlike expected utility theory, which assumes rational evaluation of final wealth.
- AEvaluate outcomes as gains and losses relative to a reference point, with losses weighing more than equal gainsCorrect
- BAlways choose the option with the highest expected monetary value
- CTreat gains and losses symmetrically around total wealth
- DMake decisions only after processing all available information perfectly
Explanation
Prospect theory says value is defined over gains and losses from a reference point and the value function is steeper for losses (loss aversion). Expected utility theory assumes rational evaluation of final wealth. The other options describe rational-agent assumptions.
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