What is the difference between objective and subjective value of currency?

Objective value is determined by the market and represents the actual exchange rate of currency. Subjective value is the psychological worth a person assigns to money based on context, such as purchase size and potential savings. For example, saving two dollars on gas might seem worth an extra trip, but saving the same amount on a car purchase typically does not.

Who developed Prospect Theory and why is it important?

Daniel Kahneman and Amos Tversky developed Prospect Theory in the 1970s to explain how people psychologically value currency and make economic decisions. Kahneman received the Nobel Prize in Economics in 2002 for this work, which demonstrated that subjective value depends on whether losses or gains are involved and the overall transaction size.

How do survey questions in Prospect Theory experiments use gambles?

Participants choose between options involving theoretical monetary gains or losses with different probabilities. In gain scenarios, participants decide whether to keep money won or risk it for a higher amount. In loss scenarios, they choose between paying a debt or risking a greater loss. Both options have the same expected value, allowing researchers to measure subjective psychological value.

What sample size and timeline are recommended for Prospect Theory surveys?

Distribute surveys to between 50 and 100 randomly selected participants, who can be tested individually or in groups. Allow approximately 15 minutes for participants to complete roughly 20 questions. Include a cover page with informed consent explaining that participation is voluntary and responses are anonymous.

What patterns do researchers typically find when analyzing Prospect Theory data?

Analysis reveals that participants overestimate the subjective value of monetary losses, especially small ones, viewing them as worth more than their objective values. Participants are more likely to take risks to avoid losses than to pursue equivalent gains. Additionally, subjective value of gains decreases when larger sums are involved, showing context-dependent decision-making.

How can Prospect Theory research be applied to real-world behavior?

Prospect Theory studies help researchers understand gambling addiction by connecting high subjective value of losses to persistent gambling despite mounting debts. Researchers pair surveys with functional MRI to identify brain regions involved in assigning subjective values. Marketing strategies also use Prospect Theory by offering perceived discounts on lower-priced items that consumers assign high subjective values to.

What makes the dependent variable in Prospect Theory experiments measurable?

The dependent variable—subjective value of currency—is measured by calculating the percentage of participants choosing each option in survey questions. By varying probabilities and monetary amounts across questions and comparing participant preferences in similar scenarios, researchers can apply perspectives on cognitive psychology to quantify how psychological factors influence perceived value independent of actual market value.

Prospect Theory

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1. Stimulus design

When options have known outcomes and probabilities, economists describe the value of each choice as the average of its outcomes weighted by their respective probabilities, what they call a choice’s expected value.
For example, a guaranteed win of $5 has an expected value of $5, and a gamble that pays out $10, 50% of the time (and nothing the other 50% of the time) also has an expected value of $5: 0.5 x 0 + 0.5 x 10 = 5.
Devise gambles that tend to lead to different decisions, despite similar or equal expected values (Figure 1), in order to design a proper survey to study Prospect Theory.

Figure 1. Two gambles consisting of choices with equal expected value ($5) as either gains (1) or losses (2). In gamble 1, the expected value of both choices is a gain of $5. In gamble 2, the expected value of both choices is a loss of $5. The choices in each gamble also have equivalent probabilities. Therefore, standard economic theory makes two predictions. First, whatever choice a person prefers in one of the gambles, they should prefer the same choice in the other gamble. A person willing to take a risk in order to win $5 should be willing to take an equivalent risk in order to avoid paying $5. And on average, over many participants, choices A and B should be picked equally often. But actual behavior does not conform to these predictions. Many more people will take the risk—choice B—in gamble 2 than would in gamble 1, because losses have greater subjective value than equivalent gains. This is called loss aversion.
When choosing sample questions for a survey, look for situations with a clear favorite between choices with equal expected values, a preference for a choice with a lower expected value, and a difference when the scenario is applied to gains compared to losses. Also consider situations with very small probabilities and with very high ones (Table 1).

A	B
[4000,1]	[5000, .9]
[-4000,1]	[-5000, .9]
[5,1]	[10, .9]
[-5,1]	[-10, .9]
[5000, .9]	[10,000, .45]
[5000, .04]	[10,000, .02]

Table 1. The first number in each bracket denotes a currency value, and the second denotes the probability associated with that outcome.

2. Procedure

Once a survey is created, give it to a large group of participants (between 50 and 100 people).
If one intends the results to be published or shared publicly in other ways, acquire the necessary human ethics approval and informed consent.
Create a cover page that informs the participant that their responses are anonymous and that they can choose not to complete the survey, and include a place for them to sign to indicate consent.
After the survey is given to an appropriate number of participants, tally up the number who chose each option—A and B—for each question.
Compare preferences expressed in related questions to reveal the nature of subjective value with respect to risk, reward, and losses.

"Prospect Theory" was devised by Daniel Kahneman and Amos Tversky, beginning in the 1970s, as a way to describe how people psychologically value currency.

On one hand, any unit of currency-like the US dollar-has an objective value, determined by the market. If a person is preparing to travel abroad and exchanging currency, it is this objective value that will dictate how many euros they can expect to receive for fifty dollars.

However, currency can also have a subjective, psychological value, which a person "assigns" to it based on many different factors, including the size of the purchase they are considering and potential relative savings.

To elaborate, a person may be willing to drive an extra mile to save two dollars on every gallon of gas, but not to save the same amount on a new, $20,000 car. Thus, two dollars is sometimes-but not always-worth an extra mile trip.

Originally formulated using survey data, Prospect Theory provides researchers with a model to predict an individual's subjective perceptions of objective monetary gains or losses.

In this video, you will learn how to create survey questions to study Prospect Theory, collect and analyze participant data in the form of survey responses, and learn how these can provide insight into the psychological value people place on currency.

In this experiment, participants complete a survey with questions pertaining to gambles-theoretical events in which they could potentially lose or gain a sum of money.

In questions dealing with gains, a scenario is presented where the participant has already received money-like winning five dollars in a raffle.

The participant must then choose between two options as to what to do with the sum: either keep all of it, or risk it for a chance to win a higher amount.

Similarly, when a participant encounters a loss question, they must pick between options of paying a debt, or risking a greater loss for a chance to have the debt erased.

The trick here is that both options to a question have the same expected value-the average amount of money gained or lost over several trials-which takes into account the probability of a win or loss.

It's the manner in which these values are presented-either as "sure things" or "risks" with a lower probability of success-which allows for an assessment of the subjective, psychological value of currency.

Participants are presented with a variety of such questions in a survey, where the probabilities of gains or loses-as well as the actual monetary amounts at stake-vary.

Here, the dependent variable is the subjective value of currency, which is determined by calculating the percentage of participants that chose a particular option to a question.

Based on the previous work of Kahneman and Tversky, it is expected that participants will overestimate the subjective value of monetary losses, especially small ones, viewing them as worth more than their actual, objective values.

To begin, create a survey with roughly 20 questions, and include questions dealing with diverse loss and gain scenarios.

Verify that both options associated with each question demonstrate the same expected value, as well as a range of monetary values with risks associated with different probabilities.

Before distributing the survey to participants, generate a cover page to include with informed consent, which explains to participants that they do not have to complete the questions, and that their responses are anonymous. Make sure to include a signature line for participants to indicate their consent.

Once the survey is finalized, distribute it to between 50 and 100 randomly selected participants. Note that individuals can be tested in groups. Allow them 15 min to complete the 20 questions.

When the participants are done, collect the surveys.

To analyze the data, for every question calculate the percentage of participants that chose each option-either A or B.

Compare participant preferences in similar questions, such as those dealing with small sums of money either lost or won.

Notice that more participants will tend to take a risk to avoid a financial loss compared to an equivalent gain, meaning that a greater subjective value is placed on monetary losses.

Also notice that participants will be less likely to risk large sums in gain scenarios, indicating that their subjective value of monetary gains can decrease depending on the context.

Now that you've learned how to create surveys to study Prospect Theory, let's take a look at how experimental psychologists are using this theory to investigate aspects of decision-making behavior.

As surveys that assess Prospect Theory deal with monetary losses and gains, these studies can aid our understanding of the psychological underpinnings of gambling and gambling addiction.

Importantly, such work has allowed researchers to connect the high subjective value of monetary losses to the tendency to keep gambling even as debts mount.

Researchers can also pair automated variations of Prospect Theory surveys with technologies like functional MRI, which can identify "activated" brain regions. This helps scientists determine the neuroanatomical basis for how participants assign subjective values to monetary sums under different situations.

Finally, Prospect Theory can also be used to develop new marketing strategies, such as stores offering perceived discounts on lower-priced items, to which consumers would assign high subjective values.

You've just watched JoVE's video on Prospect Theory. By now, you should have an idea of how to design survey questions to investigate this phenomenon, collect and analyze participants' responses, and relate the Prospect Theory to human behaviors like gambling.

In addition, you should have a grasp of how the Prospect Theory relates to the subjective and objective values of currency, which are not always the same.

Thanks for watching!