Risk preference according to prospect theory

Prospect theory is an influential and widely used behavioral economics theory that explains how people make decisions under risk and uncertainty. The theory provides an alternative to Rational Choice Theory and suggests that people often act irrationally when faced with choices that involve risk. According to the theory, people’s risk preference is determined by their level of risk aversion, which is based on a number of psychological factors. Specifically, people have a tendency to prefer outcomes related to low risk (small gains or small losses) over outcomes related to high risk (large gains or large losses). This means that when faced with a choice that involves risk, people are more likely to opt for the safer option, even if the riskier option offers rewards that are proportionately higher. This preference for low risk is also known as risk aversion.