Behavioral Economics

A field that combines insights from psychology and economics to explain why people often make decisions that deviate from the predictions of standard rational-choice models.

Israeli-American psychologists who pioneered research on cognitive biases and prospect theory, fundamentally reshaping the field of behavioral economics.

A theory developed by Kahneman & Tversky (1979) stating that people evaluate outcomes relative to a reference point and are more sensitive to losses than to equivalent gains.

The value function is S-shaped: concave for gains (risk aversion) and convex for losses (risk seeking), and it is steeper for losses than for gains.

The baseline against which outcomes are judged as gains or losses; it is often the status quo or an expectation level, not an absolute wealth measure.

The empirical finding that losses loom roughly twice as large as gains of the same magnitude, i.e., losing $100 feels about twice as painful as gaining $100 feels pleasurable.

Approximately λ ≈ 2.25, meaning a loss is psychologically weighted about 2.25 times more than an equivalent gain.

Investors tend to hold losing stocks too long (hoping to break even) and sell winning stocks too early (locking in gains), a pattern called the disposition effect.

The tendency of investors to sell assets that have increased in value while keeping assets that have decreased in value, driven largely by loss aversion.

Studies of taxi drivers show they set daily income targets and quit early on high-demand days while working longer on slow days, contrary to rational supply predictions.

The phenomenon where people value an object more highly simply because they own it, leading to a gap between willingness to accept (WTA) and willingness to pay (WTP).

Richard Thaler coined the term, and classic mug-trading experiments by Kahneman, Knetsch, and Thaler (1990) provided strong experimental evidence.