Prospect Theory would predict that a decision-maker who prefers a certain gain of $250 versus a 5% chance of winning $5,000 would, on the other hand, prefer a 5% chance of losing $5,000 compared to a loss of $ 250 for sure. However, we observe people (happily) paying $ 250 for an insurance policy that covers a potential loss of up to $ 5,000 (e.g., extended warranties for home appliances). How do Kanhneman and Tversky (1979) and Sydnor (2010) assess this apparent contradiction? Can you think of another reason why decision-makers with prospect-theory preferences might want to buy these types of insurance?

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Answer Kahneman and Tverskys Prospect Theory 1979 and Sydnors 2010 assessment provide insights into this apparent contradiction between preferences fo... View the full answer