Prospect Theory

793 Words 4 Pages
7% over the past five years. The second advisor tells the investor that the mutual fund has seen above-average returns in the past 10 years but has been declining in recent years. According to prospect theory, even though the investor is presented with the same mutual fund, he or she is more likely to buy the mutual fund from the first advisor, who expressed the rate of return as an overall 7% gain, rather a combination of both high returns and losses.

Prospect theory is based on the following five main ideas which is reference dependence, declining sensitivity, loss aversion, non-linear weighting of probabilities and susceptibility to framing effects. Prospect theory has been successfully used to explain a range of puzzles in economics,
…show more content…
The tax preparers do not internalize the client’s situation. As (tversky, 1979) stated, “The framing of acts can also reflect acceptance or rejection of responsibility for particular consequences and the deliberate manipulation of framing is commonly used as an instrument of self-control.Personal responsibility had no effect on continued commitment when the outcome was framed positively. There was less need to justify their previous decision when the results were framed positively. Applying this analysis to tax preparer decision making, there should be less need for tax preparers to justify their previous calculation in an unexpected tax refund situation. Tax preparers are likely to frame clients’ unexpected refunds positively, rather than negatively. Prospect theory predicts that decisions makers will be risk averse when the refund is framed positively (BOBKO, …show more content…
A Theory of the Allocation of Time," Becker (1965) stated that his goal was to provide, "a basic theoretical analysis of choice that includes the cost of time on the same footing as the cost of market goods (Lewbel, 1965). The standard model of deterrence was first formulated by Allingham and Sandmo(1972),who adapted Becker’s (1968)model of the economics of crime. The model is based on an assumption that taxpayers are economical rational and act maximize their self-interest. This model has been widely criticized mainly because in reality taxpayers are more compliant than the model predicts. The odds of detection and penalties are generally so low, that according to the model it would be rational to cheat, yet most people tend to pay their taxes (Braithwaite, 2008). In contrast, Becker emphasizes that there are many di§erent types of time use, just as there are many types of consumption goods, and that di§erent types of time use and consumption goods combine in di§erent ways (Lewbel,

Related Documents