Posits that individuals make making decisions under risks evaluates losses and gains relative to a reference point rather than absolute wealth. Decision-making occur in two phases: editing (framing and simplifying options) and evaluation (choosing based on prospect values). During this process, three mechanisms interplay: loss aversion, so that losses are psychologically twice as impactful as equivalent gains; probability weighting, in which people overweight small probabilities and underweight high ones; and diminishing sensitivity, decreasing the subjective value of changes as they become larger. This framework explains why people often make seemingly irrational choices, such as being risk-averse for gains but risk-seeking for losses.
Is somewhat related to Behavioral life-cycle hypothesis and Scarcity theory.
Proposed by Daniel Kahneman and Amos Tversky (1979).