Prospect Theory: The Phenomenon of Research Paper

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The vice-versa is true for losses because the function associating with the biased value and corresponding losses is steeper than the one for gains (McKeown, 2000). Consequently, the dissatisfaction associated with losses is usually greater than the pleasure associated with similar amounts of gain. Depending on whether the options or choices are framed on the basis of gains or losses, people respond differently. According to the theory, losses tend to have increased emotional impact than the same emotional impact of gains.

The two most common framing effects associated with the prospect theory are bi-directional and unidirectional effects. Bi-directional framing effects incorporate the preference reversal from mainly risk averse to mostly risk seeking or vice-versa because of the dichotic impact of the framing of the choice results. As a result, this effect is characterized by more risk-averse choices based on positive framing and more risk-seeking choices based on negative framing. On the contrary, the unidirectional effect involves no preference reversal like the bidirectional framing effects but rather incorporates the shift towards a more extreme risk preference. When the major preference is uni-directionally risk averse on both of the framing conditions, it's a more risk averse on the positive frame than a negative frame and vice versa.

In economics, the phenomenon of expected utility hypothesis is primarily a notion where the utility of a certain action is based on the overall 'betting' inclinations of the individuals involved especially when dealing where the probable result is either uncertain or risky.

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These inclinations are thus presented by a series of reimbursements (monetary or products/goods), the likelihood of repetition of incidence, the potential to evade further risks or uncertainties as well as the use of the same utility to people sharing different dynamics, capital as well as inclinations (Cynkar, 2007).

From a financial perspective, the prospect theory can be used to describe and explain some illogical financial behaviors. This is primarily because it explains the occurrence of the disposition effect, which is the predisposition for investors to hold on to losing stocks for a long period of time and sell winning stocks as soon as possible (Phung, 2012). The most reasonable course of action is to hold on to winning stocks for extra gains and sell the losing stocks to prevent rising losses. The sale of winning stocks prematurely can be understood through the consideration of Kahneman and Tversky's analysis in which individuals were willing to obtain a lower guaranteed gain of $500 rather than settling for a riskier choice that is likely to generate $1,000. The study explains reasons investors realize the gains of winning stocks.....

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