Review Paper on Prospect Theory

18 December 2012 at 10:18 am 2 comments

| Peter Klein |

We haven’t been entirely kind to behavioral economics, but we certainly recognize its importance, and have urged our colleagues to keep up with the latest arguments and findings. A new NBER paper by Nicholas Barberis summarizes the literature, focusing on prospect theory, and is worth a read.

Thirty Years of Prospect Theory in Economics: A Review and Assessment
Nicholas C. Barberis
NBER Working Paper No. 18621, December 2012

Prospect theory, first described in a 1979 paper by Daniel Kahneman and Amos Tversky, is widely viewed as the best available description of how people evaluate risk in experimental settings. While the theory contains many remarkable insights, economists have found it challenging to apply these insights, and it is only recently that there has been real progress in doing so. In this paper, after first reviewing prospect theory and the difficulties inherent in applying it, I discuss some of this recent work. While it is too early to declare this research effort an unqualified success, the rapid progress of the last decade makes me optimistic that at least some of the insights of prospect theory will eventually find a permanent and significant place in mainstream economic analysis.

Entry filed under: - Klein -, Methods/Methodology/Theory of Science, Recommended Reading. Tags: .

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2 Comments Add your own

  • 1. Bee  |  20 December 2012 at 8:10 pm

    The progress made in the past decade is anything but encouraging. We have little to show for the hours devoted to this effort beyond a few popular books. This becomes more clear when we compare BEs advances relative to other areas like computer science, management science, nano-technology or genetics. The number of people working in the field is material but the progress is not.

    I think that theory advancement in BE is unsatisfactory. We have spent more than two decades now documenting examples of biases. The cognitive explanations are week. One major problem is that many of the experiments are simple main effects studies. They do not demonstrate how the “effect” can be turned on and off.

    I thinks that Simon’s concept of bounded rationality offers a better foundation for theory development. BE has provided a platform for identifying “biases” but not a theory that extends beyond categorization.

    Researchers need to spend more time understanding how and why theory should advance in this domain. The current approach that advances just happen is not acceptable today when we see development in many areas following more defined trajectories.

  • 2. stevepostrel  |  28 December 2012 at 8:36 pm

    I’d like to plug Paul Glimcher’s Foundations of Neuroeconomics, discussed at

    http://strategyprofs.wordpress.com/2012/11/20/neuroeconomic-imperialism/

    It’s the first serious attempt I’ve seen to integrate neoclassical theory with behavioral and neurological data.

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