PROSPECT THEORY specified type of risk. Compare, for example, probabilistic insurance against all forms of loss or damage to the contents of your home and contingent insurance nat eliminates all risk of loss from theft, say, but does not cover other risks, e. g fire. We conjecture that contingent insurance will be generally more attracti than probabilistic insurance when the pre es of unprotected loss are quated. Thus, two prospects that are equi in probabilities and outcomes uld have different values depending on their formulation. Several demon strations of this general phenomenon are described in the next section The Isolation Effect components nts that the alternatives share and focus on the components tha distinguish them(Tversky [44]). This approach to choice problems may produce inconsistent preferences, because a pair of prospects can be decomposed into ommon and distinctive components in more than one way, and different deco ositions sometimes lead to different preferences, We refer to this phenomenon as PROBLEM 10: Consider the following two-stage game. In the first stage there is a probability of. 75 to end the game without winning anything, and a probability of 25 to move into the second stage. If you reach the second stage you have a choice (4,000,80)and(3,000) Your choice must be made before the game starts, i. e before the outcome of the first stage is known 25x1.0=, 25 chance to win 3, 000. Thus, in and probabilities one faces a choice between(4,000, 20)and(3, 000, 25), as in Problem 4 above. However, the dominant preferences are different in the two problems Of 141 subjects who answered Problem 10, 78 per cent chose the latter rospect,contrary to the modal preference in Problem 4. Evidently, peop and considered Problem 10 as a choice between(3, 000)and (4, 000, 80), as in Problem 3 above. he standard and the sequential formulations of Problem 4 are represented as decision trees in Figures 1 and 2, respectively. Following the usual convention d circles denote chance nodes, The essential ifference between the two representations is in the location of the decision node In the standard form( Figure 1), the decision maker hoice between tw aspects, whereas in the sequential form(Fi he faces a choice a risky and a riskless prospect. This is accor ng a ncy between the prospects without changing either probabilities or produced with perm ission of the copyright owner. Further reproduction prohibited without permission.Reproduced with permission of the copyright owner. Further reproduction prohibited without permission