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NISM Certifications · NISM-Series-X-B: Investment Adviser (Level 2) · Basics of Behavioural Finance

Under prospect theory as proposed by Kahneman and Tversky, which statement is correct about how people evaluate outcomes?

Prospect theory says people judge outcomes as gains or losses against a reference point, and a loss hurts more than an equal gain pleases. They are usually risk-averse over gains and risk-seeking over losses, unlike the traditional expected utility model of final wealth and objective probabilities.

  1. AIndividuals evaluate outcomes as gains or losses relative to a reference point, and losses loom larger than equivalent gainsCorrect
  2. BIndividuals evaluate only final wealth and treat gains and losses symmetrically
  3. CIndividuals always maximise expected utility using objective probabilities
  4. DIndividuals are risk-seeking over gains and risk-averse over losses

Explanation

Prospect theory states value is judged relative to a reference point, with a value function steeper for losses than gains. People are typically risk-averse in gains and risk-seeking in losses, which reverses the last option. Final-wealth symmetry and objective expected utility belong to traditional theory.

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