Prospect Theory or a Misuse of the Concept of Opportunity Cost?

Abstract

This paper shows that the risk seeking in the domain of losses phenomenon of prospect theory may be just: people misuse the concept of opportunity cost in the domain of losses. The reference points of Kahneman et al.'s (1979) value function in the domain of gains and in the domain of losses are different. The paper also shows that Kahneman et al.'s two-stage experiment is in fact a one-stage experiment, and their isolation effect (reversal of preferences) does not exist.

Keywords: Opportunity cost, prospect theory, reference point, isolation effect, framing effect

JEL Classification: D81