Applications of Regret Theory to Asset Pricing
32 Pages Posted: 26 Feb 2002
Date Written: March 1, 2005
This paper presents a theoretical model of asset pricing that analyses how the behavior of stock returns is affected by the presence of regret-averse investors on the market. The model helps to explain the excess volatility and autocorrelation of stock returns. In addition, the model predicts a positive correlation between future trading volume and the dispersion of the realized stock returns and helps to analyze how an improvement of stock market accessibility for non-professional traders affects the predictability of stock returns. Using recent stock market data the second part of the paper provides an empirical analysis of some of the model's implications.
Keywords: Regret Theory, Asset Pricing, Behavioral Finance
JEL Classification: G12, G19
Suggested Citation: Suggested Citation