How did risks of the Iran war get misread? Kahneman and Tversky’s Prospect Theory may have answers

At their core, they are bets, and can hence be viewed through the lens of risk—not in a vague rhetorical sense, but by means of rigorous psychological analysis of the kind that forms part of Daniel Kahneman and Amos Tversky’s Prospect Theory, particularly its four-fold pattern of risk attitudes.

This framework maps human behaviour into four quadrants based on whether an outcome involves gains or losses and whether its probability is high or low. Applied to the US-Israel-Iran war, it reveals how every major actor is behaving as the theory predicts and why such predictable behaviour is not the same as wisdom.

When there is a high probability of large gains, Prospect Theory predicts people become risk-averse, preferring to lock in what is almost certain rather than gamble for more.

For the US, the military calculus entering 2026 seemed to offer high-probability gains. Iran’s defences had been weakened by the 12-day Israeli-US campaign of June 2025. The International Atomic Energy Agency had documented Iran’s uranium enrichment approaching weapons-grade, providing a pretext.

The window for the US to lock in prospective gains was real, with Iran seeming barely months away from nuclear-breakout capability. The question was not whether to act, but when to take a sure gain. On 28 February, war began, setting in motion dynamics that have now paused, but not resolved.

If the likelihood of a bad outcome is high, however, the psychology flips: people seek risk. When people expect to lose, they gamble, which explains why cornered states do not capitulate.

Iran entered 2026 facing losses across all dimensions. Its economy was in free-fall, with inflation exceeding 40%, and its regional network of proxies like Hezbollah, Hamas and the Houthis had been all but dismantled by Israeli operations since 2023. And once the war began, its supreme leader was dead within hours of the first strike.

A rational actor facing certain humiliation might have chosen a negotiated surrender. But Prospect Theory predicts the opposite. Iran closed the Strait of Hormuz, launched hundreds of missiles at Israel and US bases, and struck Gulf states that professed neutrality. This was not irrationality but textbook highly-likely-loss behaviour.

The Hormuz gambit illustrates this well. Almost a fifth of the world’s oil flows via that chokepoint, including Iran’s own exports. But a regime staring at extinction does not optimize policy for trade flows. It reaches for a lever that might force a ceasefire or make the enemy suffer too.

The third quadrant is a domain where there is a very low probability of significant gains. In such cases, people overweight that small likelihood, paying more than what the mathematically expected payoff would justify for a long shot at a transformative outcome. It is why people buy lottery tickets and why states sometimes launch wars that the math does not favour.

Several US aims fell in this quadrant. The hope of regime change in Tehran with a democratic transition delivering a pro-West government and an end to four decades of enmity was an unlikely outcome dressed as strategy.

The US claimed a shifting menu of war objectives: preventing a nuclear weapon in Iran’s hands, securing its oil resources, achieving regime change. This multiplicity suggests fourfold-pattern thinking: some aims were near-certain, others were lottery tickets in the guise of strategy.

The problem is that overweighting low-probability gains leads to miscalibrated decisions. Washington underestimated the tail risks of its bet, including a multifront missile war that has touched Nato territory, the Caucasus area and the Levant, apart from states across the Gulf from Iran.

Quadrant 4 is the most dangerous and relevant to the world watching from Mumbai, Seoul, Berlin, etc. When losses are unlikely but catastrophic, Prospect Theory observes that people underweight them. Just as they overpay for small chances of gain, they under-prepare for small chances of catastrophe.

The low-probability, high-consequence risks of this conflict were visible well before 28 February. It was known that a Strait of Hormuz blockade would disrupt fertilizer supplies and steel manufacturing across Asia, and that killing Iran’s supreme leader would take away the one figure with the authority to call off Iran’s Revolutionary Guards, making de-escalation harder.

India, which sources much of its hydrocarbon needs from the Gulf, also sits in the fourth quadrant. Until recently, India underestimated the probability of a prolonged supply disruption. But the country is now facing a different reality, even as the ceasefire offers a temporary, tenuous relief.

Prospect Theory’s fourfold pattern is not a framework for predicting outcomes but for understanding how actors behave under uncertainty and why seemingly intelligent decision-makers make the same errors. In its hunt for certain gains, the US was blind to catastrophic tail risks, while an Iran facing certain losses took big risks in ways that maximized regional pain.

Everyone bought the lottery ticket of transformative victory while under-insuring against unlikely disasters. The ceasefire may have paused the disruption, but the world is paying that premium in energy bills, disrupted trade and the slow realization that a war nobody fully priced has costs that keep compounding. The fourfold pattern tells us that this was not a failure of intelligence. It was a failure of risk literacy.

These are the author’s personal views.

The author is professor, economics and executive director, Centre for Family Business & Entrepreneurship at Bhavan’s SPJIMR.