Regret in Global Equity Markets

Abstract

This paper investigates the relation between investment regret and the cross-section of equity returns in an international context. We measure the regret from investing in a stock as the negative of the difference between the stock's return and the maximum return that could have been achieved by a stock either in the same industry or with a similar market capitalization or book-to-market ratio. Next, we calculate one-month-ahead returns to a portfolio that is long (short) in high-regret (low-regret) stocks. First, the positive relation between regret and future returns is stronger for equal-weighted portfolios suggesting that it is more acute for small stocks. Second, the regret effect is stronger in emerging markets compared to developed markets. Third, size-based regret is more pronounced compared to industry-or value-based regret. Fourth, the effect of regret on stock returns tends to gradually decline when calculated over multiple periods. These findings are robust after controlling for various asset pricing factors and firm-specific attributes.

Keywords: regret theory, behavioral finance, equity returns, international finance

JEL Classification: G11, G12, G15, G41