Abstract
This study analyses the application of prospect theory concepts to understand stock market fluctuations. Prospect theory is the most frequently encountered alternative to utility theory when the latter is seen as insufficient in explaining empirical data. It incorporates principles of cognitive psychology and encapsulates choice behavior theories from various disciplines to put forth a more comprehensive approach in the study of patterns in consumer behavior. This research also lists various metrics to be used in the calculation of an investor’s readiness in case of an opportunity involving a risky underlying asset and further classifies investors based upon their scores in each of these five metrics. Based upon the principles of behavioral economics, this area of interest offers several challenging problems for further research and their importance is only enhanced by the ease of extension of their solutions to real world implementation.
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