Anticipated Regret and Equity Returns
83 Pages Posted: 19 Jun 2018 Last revised: 13 Jan 2020
Date Written: June 1, 2019
We investigate the cross-sectional asset pricing implications of anticipated regret for mean-variance investors. We propose a theoretical framework in which mean-variance investors anticipate regret due to deviations from the best possible return-volatility combination. We show that equity portfolios with low anticipated regret generate 7.6% more annualized alpha than portfolios with high anticipated regret. The anticipated regret premium is not fully explained by costly arbitrage, investor inattention, or prospect theory. We further decompose anticipated regret into two components, return-regret and variance-regret, and show that both components play a significant role in mean-variance investors' financial decision making under anticipated regret.
Keywords: regret theory, mean-variance investors, cross-section of stock returns
JEL Classification: G11, G12, G41
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