- Person
- Daniel Kahneman
- Lived
- 1934–2024
- Field
- Psychology, behavioural economics
- From
- Israeli-American
The story
Classical economics assumed that people choose among risky options by calmly calculating expected outcomes, valuing each possible result by the total wealth it would leave them. After publishing their work on judgment in 1974, Amos Tversky suggested that he and Daniel Kahneman study decision-making together. Kahneman, new to the field, was puzzled that textbook choice problems were described in terms of gains and losses while the theories explaining them were drawn in terms of wealth.
The two tested the standard assumption with simple questions about gambles, using a method of their own: they invented choices, examined their own preferences, and if they agreed they assumed others would too. They constructed and discarded models at a dizzying rate; Kahneman remembered one numbered 37. Their central insight was to treat changes in wealth, gains and losses relative to a reference point, as what people care about. Losses weigh more heavily than equivalent gains, a pattern they called loss aversion: most people will refuse a coin-toss bet in which they might lose $20 unless they stand to win more than $40. They also found a reflection effect: people avoid risk when choosing between gains but seek it when choosing between losses, preferring a sure $900 to a 90 per cent chance of $1,000, yet a 90 per cent chance of losing $1,000 to a sure loss of $900.
A first version, called value theory, was presented at a conference in 1975. They spent about three more years anticipating every objection, and in doing so made explicit that the objects of choice are mental representations rather than objective states of the world. They deliberately chose a meaningless name, prospect theory, so that it would be remembered as a label. It was published in 1979 in Econometrica, then the leading economics journal.
Kahneman noted that the venue was crucial: the same paper in a psychology journal would probably have had little impact on economics. According to Wikipedia, it became the most cited paper in economics. In 1992 they extended it as cumulative prospect theory.
Kahneman considered loss aversion their most useful contribution to the study of decision-making. It helps explain why people cling to the status quo, why housing markets freeze when prices fall, and why giving something up feels worse than never having it, and it was central to the 2002 Nobel Prize.
Why it matters
Prospect theory gave economists a realistic model of decision-making under risk and laid the foundations of behavioural economics.
About Daniel Kahneman
Child survivor of Nazi-occupied France who, with Amos Tversky, mapped the systematic errors of human judgment, founded behavioural economics and won the 2002 Nobel Prize in economics.
More about Daniel Kahneman
- Daniel Kahneman showed how framing flips our choicesKahneman and Tversky showed that two logically identical descriptions of a choice, such as lives saved versus lives lost, can lead people to opposite decisions.
- Daniel Kahneman named the illusion of validityWatching army officer candidates, Daniel Kahneman noticed that assessors stayed confident despite proof their predictions failed. He called it the illusion of validity, his first cognitive illusion.
- Daniel Kahneman built the Israeli army's recruit interviewAt 21, Daniel Kahneman designed a structured interview for all Israeli combat recruits. It roughly tripled the interviews' predictive power and stayed in use for decades.
- Daniel Kahneman found how we remember painDaniel Kahneman showed that memories of painful experiences depend mostly on their worst moment and their end, the peak-end rule, a finding that can make medical procedures easier to bear.
- Daniel Kahneman showed the eye's pupil tracks mental effortWith Jackson Beatty, Daniel Kahneman discovered that people's pupils dilate steadily as they hold more digits in memory, giving scientists a window onto mental effort.
- Daniel Kahneman's eureka moment about praise and blameWhen an Israeli flight instructor insisted that shouting worked better than praise, Daniel Kahneman realised he was seeing regression to the mean, the most satisfying eureka of his career.
- Thinking, Fast and Slow brought Kahneman's ideas to millionsDaniel Kahneman's 2011 book Thinking, Fast and Slow, describing fast intuitive and slow deliberate thinking, became an international bestseller and won major book awards.
- Kahneman and Tversky mapped the mind's shortcutsIn 1974 Daniel Kahneman and Amos Tversky published Judgment under Uncertainty: Heuristics and Biases, showing how mental shortcuts lead to predictable errors.
- Kahneman's theory helped launch behavioural economicsWhen a 1975 draft of prospect theory reached the young economist Richard Thaler, it explained his puzzles, such as the endowment effect, and helped launch behavioural economics.
- Daniel Kahneman championed adversarial collaborationDaniel Kahneman urged scientists who disagree to run joint experiments instead of trading hostile rebuttals, a practice he called adversarial collaboration.
Sources
- Daniel Kahneman Wikipedia
- Daniel Kahneman: Biographical NobelPrize.org
- Prospect theory Wikipedia
Another act of tikkun olam. This is part of tikkun olam, the Jewish idea of repairing the world, and every one of us can add to it.