The dopamine system has been linked to anhedonia in depression and both the positive and negative symptoms of schizophrenia, but it remains unclear how dopamine dysfunction could mechanistically relate to observed symptoms. There is considerable evidence that phasic dopamine signals encode prediction error (differences between expected and actual outcomes), with reinforcement learning theories being based on prediction error-mediated learning of associations. It has been hypothesized that abnormal encoding of neural prediction error signals could underlie anhedonia in depression and negative symptoms in schizophrenia by disrupting learning and blunting the salience of rewarding events, and contribute to psychotic symptoms by promoting aberrant perceptions and the formation of delusions. To test this, we used model based functional magnetic resonance imaging and an instrumental reward-learning task to investigate the neural correlates of prediction errors and expected-reward values in patients with depression (n = 15), patients with schizophrenia (n = 14) and healthy controls (n = 17). Both patient groups exhibited abnormalities in neural prediction errors, but the spatial pattern of abnormality differed, with the degree of abnormality correlating with syndrome severity. Specifically, reduced prediction errors in the striatum and midbrain were found in depression, with the extent of signal reduction in the bilateral caudate, nucleus accumbens and midbrain correlating with increased anhedonia severity. In schizophrenia, reduced prediction error signals were observed in the caudate, thalamus, insula and amygdala-hippocampal complex, with a trend for reduced prediction errors in the midbrain, and the degree of blunting in the encoding of prediction errors in the insula, amygdala-hippocampal complex and midbrain correlating with increased severity of psychotic symptoms. Schizophrenia was also associated with disruption in the encoding of expected-reward values in the bilateral amygdala-hippocampal complex and parahippocampal gyrus, with the degree of disruption correlating with psychotic symptom severity. Neural signal abnormalities did not correlate with negative symptom severity in schizophrenia. These findings support the suggestion that a disruption in the encoding of prediction error signals contributes to anhedonia symptoms in depression. In schizophrenia, the findings support the postulate of an abnormality in error-dependent updating of inferences and beliefs driving psychotic symptoms. Phasic dopamine abnormalities in depression and schizophrenia are suggested by our observation of prediction error abnormalities in dopamine-rich brain areas, given the evidence for dopamine encoding prediction errors. The findings are consistent with proposals that psychiatric syndromes reflect different disorders of neural valuation and incentive salience formation, which helps bridge the gap between biological and phenomenological levels of understanding.