Prospect Theory and Framing - Part 1 | Bryan Foltice Behavioral Finance Podcast (EP. 5)

Welcome to the Bryan Foltice behavioral finance podcast. In this episode, we continue our conversation on a previous podcast by doing a deeper dive into Prospect Theory. Here, we learn that prospect theory is four-fold and how to understand and use the prospect theory utility function. 👉 Subscribe to our channel to stay tuned: https://cutt.ly/rwfRZWED Prospect Theory and Framing are two psychological concepts that play a significant role in understanding how people make decisions and evaluate outcomes, particularly in situations involving risk and uncertainty. These concepts were developed by psychologists Daniel Kahneman and Amos Tversky and have had a profound impact on the field of behavioral economics. Prospect Theory describes how people make decisions when faced with potential gains and losses. It suggests that individuals do not evaluate outcomes in absolute terms, but rather in relation to a reference point, often called the "status quo" or the "reference point." The theory proposes two key components: Value Function: People tend to view potential gains and losses in a nonlinear manner. In the domain of gains, the perceived value diminishes as the amount of gain increases. In the domain of losses, losses are felt more acutely, and the pain of a loss is greater than the pleasure from an equivalent gain. Decision Weighting Function: People tend to assign different probabilities to potential outcomes when making decisions. In situations of risk, individuals may overweight low-probability events, and underweight high-probability events. Prospect Theory suggests that people often make decisions that aim to avoid losses rather than maximize gains, even if the rational economic model suggests otherwise. Framing refers to how information is presented or "framed" to individuals, which can influence their perceptions and decisions. Different ways of presenting the same information can lead to different choices due to cognitive biases. Kahneman and Tversky's research demonstrated that people are sensitive to the way information is framed, often making decisions based on how options are presented rather than their actual value. Clicking the timestamps below for a quick view of every action. 00:00 Introduction 04:17 Decision #1 - Gain Domain - Risk Averse 07:06 Decision #2 - Loss Domain - Risk Seeking 10:00 Diminishing Value Sensitivity - Prospect Theory Utility Function 16:19 Four Fold Pattern of Prospect Theory - Decision #3 - Gain Domain 20:34 Four Fold Pattern of Prospect Theory - Decision #4 - Loss Domain 27:53 Integration vs. Segregation - Prospect Theory Utility Function on Multiple Coin Flips Both Prospect Theory and Framing provide insights into the ways human decision-making deviates from traditional economic theories that assume people are always rational and purely self-interested. These concepts are widely used in various fields such as economics, marketing, psychology, and public policy to better understand and predict how people make choices in complex situations. My name is Dr. Bryan Foltice and I am an Associate Professor of Finance at Butler University in Indianapolis, Indiana. My main interest in research and teaching is in the area of Behavioral Finance. The goal of this Podcast and Channel is to provide a comprehensive look at this interesting topic and I've started the Podcast and YouTube Channel as mini-lectures for my Behavioral Finance course at Butler. I hope you enjoy the content and learn all about the topic of Behavioral Finance. Make sure that you click the "Like" button and also share this video with your friends and others who might also be interested in learning more about prospect theory and framing. Please click "Subscribe" and click the bell icon to keep up to date with new videos from Dr. Bryan Foltice - Behavioral Finance. If you've got any questions or feedback about this video content, please leave a comment in the comments section. "To Find out more about Bryan Foltice Behavioral Finance: Website - www.bryanfoltice.com Instagram - www.instagram.com/bryanfoltice Linkedin -   / bryan-fol.  . Disclaimer: www.bryanfoltice.com/cv #prospecttheory #framing #behavioralfinance #bryanfoltice #financialdecisions #prospecttheoryexample #behavioralfinancebiases #prospecttheoryexplained #marketefficiency #psychology #finance