Prospect Theory (explained in a minute) - Behavioural Finance

Summary

A 1995 study of Olympic medal winners revealed that bronze medalists are often happier than silver medalists. This stems from how they perceive their achievements: silver medalists focus on their near-miss with gold, seeing their outcome as a loss, while bronze medalists compare themselves to fourth place and feel grateful for winning a medal at all. This phenomenon aligns with prospect theory, which shows that people process gains and losses irrationally, feeling the pain of loss more intensely than the joy of an equivalent gain. This bias affects how we view success and failure.

Takeaways

• 🥉 Bronze medalists are generally happier than silver medalists.
• 🧐 This is because of how medalists perceive their outcomes in relation to a reference point.
• 🥈 Silver medalists often focus on how close they came to winning gold, seeing their result as a loss.
• 👇 Bronze medalists, on the other hand, focus on what could have been a worse outcome, such as not winning a medal at all.
• 🤔 Prospect theory suggests that people process gains and losses in an illogical way, with losses feeling more impactful than gains.
• 💸 In financial terms, people prefer a single gain over an equivalent gain that involves a loss, even if the end result is the same.
• 🔍 The feeling of pain from a loss is two to three times stronger than the joy from a gain of the same amount.
• 😢 This explains why some silver medalists feel disappointed, even though they are the second-best in the world.
• 😅 Bronze medalists feel happier because any outcome above not winning a medal is perceived as a gain.
• 🔄 The study highlights how people irrationally value their outcomes based on perceived gains and losses.

Q & A

What does the study from 1995 about Olympic medal winners suggest?

The study suggests that bronze medal winners, on average, appear happier than silver medal winners.

Why do silver medalists tend to feel less happy than bronze medalists?

Silver medalists often focus on the fact that they 'almost' won the gold medal, which makes them feel like they lost, while bronze medalists compare themselves to those who didn’t win any medal, making them feel like they gained something.

What is the primary reference point for silver and bronze medalists in the study?

The silver medalist’s reference point is the gold medal, so they focus on what they missed. The bronze medalist's reference point is not winning a medal, so they focus on what they gained.

How does prospect theory explain the emotional response of the silver and bronze medalists?

Prospect theory explains that people process gains and losses illogically, giving more emotional weight to losses than equivalent gains. This is why silver medalists, despite being second best, may focus on losing the gold.

What does the term 'irrational reaction' refer to in the context of silver medalists?

The 'irrational reaction' refers to silver medalists feeling disappointed or like the 'first loser,' even though they are second best in the world, because they focus on not winning the gold.

How does prospect theory relate to financial decisions?

In financial terms, people tend to feel more pain from losing money than the joy they feel from gaining the same amount, even if the net result is the same. For example, losing $50 after gaining $100 feels worse than simply gaining $50.

What is the emotional weight of losses compared to gains according to prospect theory?

According to prospect theory, the pain from a loss is two to three times greater than the joy from an equivalent gain.

Why is the concept of 'perceived gains or losses' important in this study?

It’s important because the athletes’ happiness is shaped by how they perceive their situation relative to a reference point—whether they focus on what they gained (bronze) or what they lost (silver).

What advice does the script give to people feeling disappointed in similar situations?

The script advises gaining perspective, suggesting that even if you didn’t win first place, you should still find joy in achieving something significant.

How does this study help explain why people sometimes process achievements or losses in an illogical way?

The study, along with prospect theory, helps explain that people tend to overemphasize losses, even when they’ve achieved something great, leading to illogical feelings of disappointment or dissatisfaction.