Amos Tversky

Much experimental evidence indicates that choice depends on the status quo or reference level: changes of reference point often lead to reversals of preference. We present a reference-dependent theory of consumer choice, which explains such effects by a deformation of indifference curves about the reference point. The central assumption of the theory is that losses and disadvantages have greater impact on preferences than gains and advantages. Implications of loss aversion for economic behavior are considered.

Introduction Expected utility theory has dominated the analysis of decision making under risk. It has been generally accepted as a normative model of rational choice (Keeney and Raiffa, 1976), and widely applied as a descriptive model of economic behavior (e.g., Friedman and Savage, 1948, and Arrow, 1971). Thus, it is assumed that all reasonable people would wish to obey the axioms of the theory (von Neumann & Morgenstern, 1944, and Savage, 1954), and that most people actually do, most of the time. The present paper describes several classes of choice problems in which preferences systematically violate the axioms of expected utility theory. In the light of these observations we argue that utility theory, as it is commonly interpreted and applied, is not an adequate descriptive model and we propose an alternative account of choice under risk. Critique Decision making under risk can be viewed as a choice between prospects or gambles. A prospect ( x 1 , p 1 ; …; x n , p n ) is a contract that yields outcome x i with probability p i , where p 1 + p 2 + … + p n = 1. To simplify notation, we omit null outcomes and use ( x, p ) to denote the prospect ( x, p ; 0, 1 – p ) that yields x with probability p and 0 with probability 1 – p . The (riskless) prospect that yields x with certainty is denoted by ( x ). The present discussion is restricted to prospects with so-called objective or standard probabilities.