Thinking, Fast and Slow

by Daniel Kahneman

The fundamental ideas of prospect theory are that reference points exist, and that losses loom larger than corresponding gains. Observations in real markets collected over the years illustrate the power of these concepts. A study of the market for condo apartments in Boston during a downturn yielded particularly clear results. The authors of that study compared the behavior of owners of similar units who had bought their dwellings at different prices. For a rational agent, the buying price is irrelevant history—the current market value is all that matters. Not so for Humans in a down market for housing. Owners who have a high reference point and thus face higher losses set a higher price on their dwelling, spend a longer time trying to sell their home, and eventually receive more money.