Prospect theory is a psychological idea that tries to define how we make decisions. When we are presented with different options which are risky, and cause us uncertainty we decide on the basis of losses not gains. We are more influenced by loss than by gains. For example if offered a way of increasing our pot of money most of us would choose to keep what we have. Rather than take the risk of increasing it. Prospect Theory

1. Certainty – most people will choose the more certain option rather that the riskier option even if that riskier option might give a better return.
2. Small probabilities – most of us ignore small probabilities even under the threat of loss.

3. Relative positioning – we compare ourselves to others. If we earn more than the other people we feel better. If we don’t we feel worse off. So even if we earn more, we perecive it to be less than others – so we feel worse off!
4. Loss aversion – we tend to focus on our losses rather than our gains!

Again it appears that we are built to avoid losses and more importantly to avoid feelings of pain. If the better option involves pain: we avoid the better option.

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